PHILLIPS CURVE

PREVIOUS YEAR QUESTION SOLVED
2016 JULY III
Assertion (A) : Monetarists disagreed with the Phillips curve analysis.
Reason (R) : There are no unique correspondence of % inflation rate with % unemployment rate.
Answer from the codes below:
Code:
A) Both (A) and (R) are true and (R) is the correct explanation of (A).
B) Both (A) and (R) are true and (R) is not the correct explanation of (A).
C) (A) is true and (R) is false.
D) (A) is false and (R) is true.
ANS: (A) The findings of A.W. Phillips in ‘The Relationship between Unemployment and the Rate of Change of Money Wages’ in the United Kingdom 1861–1957 suggested there was an inverse correlation between the rate of change in money wages and unemployment. Rise in unemployment was associated with declining wage growth and vice versa. This analysis was later extended to look at relationship between inflation and unemployment.
Monetarists criticized the idea of Phillips curve trade off (inverse relationship between inflation and unemployment). They argue that in the long run there is no trade off as, Long Run AS is inelastic. Monetarists argue that if there is an increase in aggregate demand, then workers demand higher nominal wages. When they receive higher nominal wages, they work longer hours because they feel real wages (purchasing power) have increased. But soon they will realize that the price levels of goods and services are also increased (inflation) and even though their nominal income has increased no change has happened to real wages. The purchasing power remains the same as earlier so they will withdraw the additional labour supplied and the unemployment level remains the same.