Can you provide more details regarding the phillips curve and the - ProProfs Discuss
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Can you provide more details regarding the phillips curve and the sacrofics ratio?

Asked by Samantha, Last updated: Nov 04, 2021

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John Smith

John Smith

John Smith
John Smith

Answered Sep 08, 2016

The phillips curve suggests an inverse relationship between unemployment and inflation. When unemployment is high, inflation tends to be low. When unemployment is low, inflation tends to be high. According to the theory, unemployment can be reduced in the short run by increasing the price level. Any attempt to lower the price level, however, can result in increased unemployment. There is a ratio known as the sacrifice ratio that describes the extent to which gdp must be reduced - leading to higher unemployment - in order to achieve a 1% decrease in inflation. Some have suggested that the sacrifice ratio is as high as 5:1. In other words, to decrease inflation by 1%, gdp would have to drop by as much as 5%. This, of course, could lead to a large increase in the number of unemployed. From this sacrifice ratio, you can see the connection to the phillips curve: if the bank of canada wanted to reduce inflation by 1%, they would likely raise interest rates. the higher rate would slow the economy, ultimately reducing gdp. By reducing gdp enough, a targeted drop in inflation could be achieved. but as gdp falls, resulting in a drop in inflation, an increase in unemployment is the sacrifice we face.

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