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Chapter Review Chapter 20: Inflation and Unemployment

  1. Other things being equal, in the short run, higher un¬ employment is associated with lower inflation. This relationship is called the Phillips curve.
  2. Other things being equal, lower output is associated with lower inflation. This relationship is called the short-run inflation adjustment (SRIA) curve.
  3. The level of inflation associated with any particular level of cyclical unemployment or output gap will in¬ crease as expectations of inflation increase. As a result, if the government attempts to maintain unemployment at too low a rate, the inflation rate will continually increase, as each increase in inflation is built into individuals’ expectations. The expectations-augmented inflation adjustment curve reflects the effects of inflationary expectations.
  4. The unemployment rate at which inflation is stable—at which actual inflation is equal to expected inflation—is called the natural rate of unemployment. Saying that inflation is stable when the output gap is zero expresses the same idea.
  5. The natural rate of unemployment can change because of changes in the structure of the labor force or increasing competition in labor and product markets.
  6. Inflation shocks such as oil price fluctuations will affect inflation, for given levels of output and inflationary expectations. A sharp rise in oil prices, for example, shifts the SRIA curve up.
  7. A number of governmental policies encourage technological advance: patents, direct spending on research, tax incentives to encourage corporate R & D, temporary protection from technologically advanced foreign competitors, and the relaxation of antitrust laws to allow potential competitors to work together on research projects.
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