# 13.2 The policy implications of the neoclassical perspective  (Page 2/13)

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Visit this website to read “The Federal Reserve Bank of Cleveland’s Economic Commentary: A New Approach to Gauging Inflation Expectations” by Joseph G. Haubrich for more information about how expected inflation is forecast.

## The neoclassical phillips curve tradeoff

The Keynesian Perspective introduced the Phillips curve    and explained how it is derived from the aggregate supply curve. The short run upward sloping aggregate supply curve implies a downward sloping Phillips curve; thus, there is a tradeoff between inflation and unemployment in the short run. By contrast, a neoclassical long-run aggregate supply curve will imply a vertical shape for the Phillips curve, indicating no long run tradeoff between inflation and unemployment. [link] (a) shows the vertical AS curve, with three different levels of aggregate demand, resulting in three different equilibria, at three different price levels. At every point along that vertical AS curve, potential GDP and the rate of unemployment remains the same. Assume that for this economy, the natural rate of unemployment is 5%. As a result, the long-run Phillips curve relationship, shown in [link] (b), is a vertical line, rising up from 5% unemployment, at any level of inflation. Read the following Work It Out feature for additional information on how to interpret inflation and unemployment rates.

## Tracking inflation and unemployment rates

Suppose that you have collected data for years on the rates of inflation and unemployment and recorded them in a table, such as [link] . How do you interpret that information?

Year Inflation Rate Unemployment Rate
1970 2% 4%
1975 3% 3%
1980 2% 4%
1985 1% 6%
1990 1% 4%
1995 4% 2%
2000 5% 4%

Step 1. Plot the data points in a graph with inflation rate on the vertical axis and unemployment rate on the horizontal axis. Your graph will appear similar to [link] .

Step 2. What patterns do you see in the data? You should notice that there are years when unemployment falls but inflation rises, and other years where unemployment rises and inflation falls.

Step 3. Can you determine the natural rate of unemployment from the data or from the graph? As you analyze the graph, it appears that the natural rate of unemployment lies at 4%; this is the rate that the economy appears to adjust back to after an apparent change in the economy. For example, in 1975 the economy appeared to have an increase in aggregate demand; the unemployment rate fell to 3% but inflation increased from 2% to 3%. By 1980, the economy had adjusted back to 4% unemployment and the inflation rate had returned to 2%. In 1985, the economy looks to have suffered a recession as unemployment rose to 6% and inflation fell to 1%. This would be consistent with a decrease in aggregate demand. By 1990, the economy recovered back to 4% unemployment, but at a lower inflation rate of 1%. In 1995 the economy again rebounded and unemployment fell to 2%, but inflation increased to 4%, which is consistent with a large increase in aggregate demand. The economy adjusted back to 4% unemployment but at a higher rate of inflation of 5%. Then in 2000, both unemployment and inflation increased to 5% and 4%, respectively.

Step 4. Do you see the Phillips curve(s) in the data? If we trace the downward sloping trend of data points, we could see a short-run Phillips curve that exhibits the inverse tradeoff between higher unemployment and lower inflation rates. If we trace the vertical line of data points, we could see a long-run Phillips curve at the 4% natural rate of unemployment.

what is crowding out effect?
Keynesian theory of employment
it's about use of Fiscal policy.
yvonne
yar what actually means of APc. averge means?. can someone give a best example plz
APC is average propensity to consume n this refers to ratio of consumption expenditure to corresponding level of income
Vishakha
then it means both MPC and ApC are same ?
Asrar
which model predicted a global collapse in the world's social and economic system before the year 2010
Abinash
yes
what is the formula of mixed income ?
NDPfc = COE + OS +MI MI=NDPfc- COE- OS
Vishakha
labor force in.Nigeria is seen as .......?
Is demand the same as being in need of a product?
yeah
Demand is defer from only need of products
Zubairu
need is the primary and main root of demand. but demand is the result of combination of need; income capacity and desire to expend of money for that product.
Ramu
products or services
jax
what is price determination?
why are imports subtructed when GDP is calculated in the expenditure approach
nati
what is fiscalpolicy
The way of the government expenses and other analysis
Zubairu
It explains government spending and how it helps to direct the economy towards the desired direction. For instance, if the govt of a nation is desirous of achieving economic growth and development, then the govt will adopt an expansionary fiscal policy which imply more spending by the govt.
Sunday
and politics party important
politics party important
mujtaba
Which party is that
Zubairu
persons who stopped searching for jobs but would accept if the opportunity presents itself
persons who are unemployed whether they are underage, retired or incapacitated
Torissa
the us economy is best characterized as?
Shekeriah
what is the impact of fiscal policy in the short and long run in the AD/AS model...
What is demand
Demand is the desire for a commodity backed by the willingness and the purchasing power too.
Ajay
what is the impact of the higher tax rate on the business and the economy at large..?
aggregate demand decreases and GDP decreases in the long run prices will decrease because aggregate supply will shift to the right and increase
Murabit
Thanks, Murabit
Hydrammeh
But still I will need more explanation
Hydrammeh
no problem tax rate is a form of fiscal policy so any time the government changes spending or taxes it will directly affect the economy
Murabit
but remember that there at different economic views on fiscal policy there is classical,Keynesian and moneterism
Murabit
if taxes increase aggregate demand decreases causing a fall in prices causing a fall in the money demand lowering interest rate and increasing investment spending in turn increasing prices
Murabit
thanks so much Murabit
Hydrammeh
what is Ricardo effect
Sera
why is direct tax superior than indirect tax?
Saz
@Saz Bh! The reason why direct tax superior than indirect tax because during a period of prosperity, direct tax fetch more revenue as they are progressive but indirect taxes are proportional and do not fetch as much revenue as direct taxes
Sera
thank u
Saz
what is the difference between demand and aggregate demand?
Era
The difference between market demand and aggregate demand delineates the fundamental difference between microeconomics and macroeconomics. Microeconomics is concerned with the supply and demand of specific goods and services. Macroeconomics is concerned with a nation's total supply and demand of all
Pankaj
thank u Pankaj 😁
Era
most welcome
Pankaj
what is Function of Money in mixed economy.?
Pankaj
what is the pinnacle importance of the Banks in the country's Economy
MUBIANA