J
Jinnentonix
Member
Hi there
I've been trying to better understand how this theory works and there's one bit which I'm having difficulty on.
I can understand that, if the government attempts to reduce unemployment below NAIRU, the resultant demand pull inflation will cause people to expect higher levels of inflation. This new expectation will cause the Phillips curve to shift upward.
The textbook states words to the effect that, after the Phillips curve shifts upwards, 'if nominal AD continued to increase at the same rate, real aggregate demand would fall and unemployment would return to NAIRU' (see page 12 of chapter 19).
This explanation is somewhat vague to me at least. That is, I don't understand fully why the economy moves from B to C on the diagram on page 11.
Firstly, I don't understand what 'same rate' means. Is it implied that nominal AD increased by 3%? Wondering if this example could be illuminated with numerical examples regarding nominal AD?
Secondly, how does the fact that the nominal AD increase is swallowed by prices increases directly affect employment (but see my proposed explanation below).
Thirdly, is this a valid explanation for exam purposes?
1. An increase in inflationary expectations would cause workers to demand higher wages.
2. These wage demands would cause those firms to cut output and employment (thus causing unemployment rate to revert to NAIRU) along the new Phillips curve.
Could it be said that the ultimate outcome is that employment reverts to NAIRU and the demand pull inflation caused by the government's actions in raising AD is replaced by expectations-based inflation - which now persists until expectations are changed?
Thanks for any help!
I've been trying to better understand how this theory works and there's one bit which I'm having difficulty on.
I can understand that, if the government attempts to reduce unemployment below NAIRU, the resultant demand pull inflation will cause people to expect higher levels of inflation. This new expectation will cause the Phillips curve to shift upward.
The textbook states words to the effect that, after the Phillips curve shifts upwards, 'if nominal AD continued to increase at the same rate, real aggregate demand would fall and unemployment would return to NAIRU' (see page 12 of chapter 19).
This explanation is somewhat vague to me at least. That is, I don't understand fully why the economy moves from B to C on the diagram on page 11.
Firstly, I don't understand what 'same rate' means. Is it implied that nominal AD increased by 3%? Wondering if this example could be illuminated with numerical examples regarding nominal AD?
Secondly, how does the fact that the nominal AD increase is swallowed by prices increases directly affect employment (but see my proposed explanation below).
Thirdly, is this a valid explanation for exam purposes?
1. An increase in inflationary expectations would cause workers to demand higher wages.
2. These wage demands would cause those firms to cut output and employment (thus causing unemployment rate to revert to NAIRU) along the new Phillips curve.
Could it be said that the ultimate outcome is that employment reverts to NAIRU and the demand pull inflation caused by the government's actions in raising AD is replaced by expectations-based inflation - which now persists until expectations are changed?
Thanks for any help!