ABSTRACT

This chapter focuses on the relationship between inflation and unemployment. The Phillips curve is an extension of the aggregate supply (AS) curve, expressed in terms of inflation and unemployment. The difference between the AS curve and the modern theory of the Phillips curve lies in the treatment of expectations. In the aggregate supply-aggregate demand (AS-AD) model, assumed that the expected price level would equal the lagged value of the price level, this means that the expected rate of inflation in the AS model is always zero, because people anticipate that prices will remain constant. In the long run, the inflation and unemployment rates return to their original values, since the monetary policy has not changed. A simulative fiscal policy has a short-run inflationary effect, but no long-run effect on inflation. The real money supply changes, causing Keynes effects alters the level of aggregate demand and the unemployment rate.