The Philips curve describes the relationship between inflation and unemployment in an economy. Inflation can be defined as a rise in the general price level of goods and services over a given time period. Meanwhile, unemployment exists when someone who is actively seeking for job but unable to find it. The Philips curve itself shows that there is a negative or inverse relationship between inflation and unemployment rate. Stated simply, the lower the unemployment in an economy, the higher the rate of inflation will be. (Gassali, 2011) 1.1 Story behind the Philips curve
For example, after the economy has just been in recession, the unemployment level will be extremely high. This high unemployment level indicates that there is a labor surplus. As the economy started to grow, the aggregate demand will goes up and leading to an increase in employment as well. At first, there will be little pressure for a raise in wages. However, as the economy growing faster and faster and more people are getting employed, there will demand for a higher wages. This happen is because people now have a greater wages bargaining power. This increase in wages will increase the firm’s cost of production and this high costs will definitely passed on to the consumers in the form of higher prices. Therefore, a decrease in unemployment will lead to an increase in inflation and vice versa. (A SHORT NOTE ON INFLATION, UNEMPLOYMENT AND PHILIPS CURVE) 1.2 The policy implication of Philips curve
Studies have shown that Philips curve is useful in policymaking and most importantly in forecasting the inflation. It can be used to predict what level of unemployment will trigger high inflation which can then in turn be harmful to the investment climate. Thus, on the part of the policymakers and analysts, a better understanding of the Philips curve is needed for a better coordination of policy. (Bagsic, 2004)
1.3 Limitation of the study
Even though it has...
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