Phillips Curve

The Phillips curve is a graphical representation of the relationship between unemployment rate and the rate of inflation in an economy. It was derived by A.W.H. Phillips during his study of unemployment and wage inflation in the United Kingdom economy from 1861 to 1957. This has been a major macroeconomics milestone in the study of these two variables. Through his rigorous studies, Phillips discovered the inverse relationship between unemployment and wages inflation. He observed that; when the level of unemployment was high, there was an increase in salaries; and when unemployment levels were low, it resulted in a rise in the wages.

As a result of these observations, Phillips made the following deductions;

• That the labor market is tighter when employment rate is low. This led to the firms raising the wages so as to attract the scarce labor force.
• When the rate of unemployed was high, there was no limited labor, and the companies tended to relax and offer lower wages.

The Phillips curve is an average representation of the behavior of unemployment and wage over a business cycle. Moreover, Phillips observed that the wage inflation that led to a given unemployment level would persist for some time.

This concept was adopted by the economists in policy derivation, analysis, and research on different economic situations that involved unemployment and wages. For a wider application, the economists replaced wages with prices. However, the concept of Phillips curve faced criticism from Milton Friedman and Edmund Phelps who argued that employers and workers who are rational and informed only pay attention to the real wages. They defined real wages as the inflation-adjusted wages holding the purchasing power.