Inflation and Phillips Curve answers all the problems which were contained within the Keynesian Theory. The curve diagrammatically depicts an empirically derived relationship between unemployment and money wage growth. The creation of the curve has helped many economists of the post Keynesian period to develop on the Keynesian Theory. The curve diagrammatically displays the inflation theory. It explores the phenomenon of inflation from a perspective of pushing the demands beyond full employment.
Contents of the Phillips Curve
Phillips Curve explains the inflation phenomenon encompassing two aspects. Those aspects are Demand Pull and Cost Push. The demand pull inflation is caused when an economy faces the pressure created by excess demand as it proceeds towards full employment and beyond. The condition of progression beyond the full employment level of output create that extra pressure on the economy leading to the phenomenon of inflation. In such a situation the output fails to match the demand because of the stringency of full employment. Therefor the only remedy is to clear off the goods in the market and to achieve this goal the prices of the good are raised.
The cost-push theory also referred to as the seller's inflation lays down that in an imperfect economy the companies set prices of products that are in accord with the mark-up formula. The formula is:
p = (1m) w
In the formula p stands for price, m for mark-up and w for wage. When the economy of a country marches towards full employment the strength of labors increases and they are in a position to demand more in terms of wages. In order to keep their profit intact the employers will raise the prices of goods which in turn keeps their mark-up intact. In such a situation the labors would demand for an increased wage rate which would in turn influence the price of goods and the price would rise. The economies policy is an efficient way to combat this kind of inflation.
Phillips Curve also depicts in a graphical way the situation in which the unemployment rate would be zero. In such a condition the price inflation(wage inflation) rises. Both the theories are different in nature since one explains about the demand factor and the other explains about the supply factor.
The famous economist Lerner also recognized another situation of high unemployment where the employers are in a strong position to bargain hence resulting in the rise of price. This phenomenon is known as stagflation.
Thus, Phillips Curve completed the Keynesian Theory as well as opened new vistas for the formulation of policies.