Question

Why is the Phillips curve downward sloping?

Use the model of aggregate demand and aggregate supply to explain with graph. (18marks)

Answer 1

Philips curve shows the inverse relationship between unemployment and inflation. Philips curve is downward sloping because higher inflation shows lower unemployment and vice versa. The shift of Philips curve is based on the fiscal and monetary policy. If there is both inflation and unemployment occurred simultaneously it will lead to stagflation. The aggregate supply curve will shift with respect to supply shocks and changes in inflationary expectations. This shift in supply curve will shift the Philips curve. The Philips curve is downward sloping in short run and it is in vertical shape in long run. If there is rise in government spending, the aggregate demand curve will shift right. By expansionary monetary policy, the aggregate supply curve will shift. Both government and monetary authority will respond on the basis of the change in inflation rate. If there is shift in aggregate supply with rise in money supply, this will shift the Philips curve. Thus the inflation rate will fall down and the rate of unemployment rises. LRAS Price level SRAS P2 P1 PO AD' AD YO Y* Y1 Quantity With rise in demand the price level will raised and output with existing technology. At the same time the unemployment will rise.