The Phillips Curve - Paper Example

Published: 2021-08-02
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George Washington University
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The Philips curve was developed by William Phillips which seeks to establish an empirical model of the relationship between inflation and unemployment. The Phillips curve holds that unemployment and inflation have an inverse relationship in an economy at different points of time. Phillip argued that the inverse relationship between unemployment and inflation is stable in that where there is spontaneous economic growth inflation occurs which leads to more jobs hence reducing unemployment. The Philips curve holds that a change in unemployment within the economy results in predictable price inflation. The Phillips curve depicts the relationship between inflation and unemployment as a downward sloping curve which is concave in shape (Snower, Dennis J., and Mewael F. Tesfaselassie 835).

In the Phillips curve, the inflation is plotted on the y-axis whereas unemployment is plotted in the x-axis. An increase in inflation has a positive effect on unemployment by decreasing unemployment in an economy while a decrease in inflation reduces the number of jobs available in an economy. The Phillips curve notes that with every increase in fiscal stimulus in an economy stimulates aggregate demand which leads to the increased demand for labor and decreases the number of unemployed people within an economy. On the other hand, an increase in labor demand causes companies to increase wages to attract better-equipped employees and attract a talent pool. However, with the increase in wages causes organizations to increase their corporate cost of wages which companies pass along to the final consumers in price increases causing inflation. The government strives to achieve a tradeoff between the inflation and unemployment through the monetary policies as well as the establishment of the stop-go strategy which seeks to establish a specific target rate of inflation while using the monetary policies to expand or contract the economy to achieve the set inflation target. However, despite the government interventions in the 1970s there was stagflation which is sustained unemployment, high price inflation and stagnated economic growth (Snower, Dennis J., and Mewael F. Tesfaselassie 835).

The invisible hand

The invisible hand is an economic market concept that was coined by Adam Smith who believed that the economy best works when there are less control and the players in the market works for their own individual interests. The invisible hand can be referred to as a market force that controls the demand and supply of goods and services in a free market to reach an equilibrium. Adam Smith noted that the economy can work well if the government leaves the people alone to buy and sell freely without any control of prices and the type of goods availed in the market. Uncontrolled and equal competition amongst the players in the market leads to positive and sustainable output in the market. In a free market, the government has less control on prices as well as entry or exit in the market. If a market player charges exorbitant prices the consumers buy from the other traders with friendly prices. Therefore, traders are forced to lower their prices to sustainable prices without any control from the government which protects the consumers in the market from selfish traders. The invisible hand enables the buyers to get their desired goods and services in the market at their desired prices and also quality. The invisible hand leads to the sustainability of the economy in which the wealthy owners of the factors of production are forced to avail resources at favorable prices to those that do not have them which is very important in the creation of a market. The invisible hand is able to resolve all the injustices in the market by ensuring the prices of labor are at equilibrium while business organizations charge reasonable prices for their goods and services to those who cannot produce their own goods and services (Swanson, Barrett 157-163). The invisible hand is fair and rational than any top down the regulation that the government can establish to control an economy. However, the invisible hand takes time for the economy to reach the equilibrium which forces the government to use its visible hands through policies to promote the sustainability of the economy.

The principle of comparative advantage

The principle of comparative advantage argues that it is important for economies and the government to focus on what they can produce efficiently even when they have the absolute advantage to facilitate the production of different products. On the other hand, other nations should also focus on what they can produce more efficiently and at the lowest cost and export the surplus to the other countries. The principle of comparative advantage has forced many countries to sign free trade agreements which encourages the access and flow of goods and services between different countries depending on the country principle of comparative advantage. The principle of comparative advantage is behind the growing globalization as well as friendliness between different countries with the aim of tapping into goods and services that the countries are able to effortlessly produce (Levchenko, Andrei A., and Jing Zhang 96). For instance, Germany is the leading country in machinery production while Africa provides vast amounts of agricultural products that are purchased by the German population while the people in Africa buy machinery in Germany for agricultural production. Therefore, the principle of comparative advantage argues that a country should concentrate on what they are best at and leave the rest to the other countries.

Rational choice theory

The rational choice theory is an economic concept that argues that people always make wise and logical financial decisions that provide them monetary benefits of satisfaction within the available choices. The concept of rational choice theory also argues that people will always make decisions that contribute to best to their self-interest. In this case, people seek to maximize their advantage in business transactions as well as monetary investment and minimize possible loses. The theory holds that humans base their decisions on rational calculations and seek to maximize pleasure or profit from every single undertaking. Therefore, in order to understand social change and actions of individuals, it is prudent to observe the rational decisions of the individuals (Kebede, Bereket 5401). However, rational choice theory is dependent on the availability of information which enables individuals to make the most beneficial decisions. Emotions are also significant detrimental factors in making rational decisions in accordance with the rational choice theory which was evidenced in the recent Brexit on which it was based on emotions and not the rational factors that Britain stood to benefit after leaving the European Union.

Works Cited

Kebede, Bereket. "Rational Choice Theory." Encyclopedia of Quality of Life and Well-Being Research. Springer Netherlands, 2014. 5401-5403.

Levchenko, Andrei A., and Jing Zhang. "The evolution of comparative advantage: Measurement and welfare implications." Journal of Monetary Economics 78 (2016): 96-111.

Snower, Dennis J., and Mewael F. Tesfaselassie. "Job Turnover, Trend Growth, And The Long-Run Phillips Curve." Macroeconomic Dynamics 21.4 (2017): 835-861.

Swanson, Barrett. "The Invisible Hand." Dissent 64.1 (2017): 157-163.

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