THEORY
1-What is the Phillips curve? Draw it. To which economic thinking would you associate this curve with its original design?
The original concept, of Phillips Curve, was introduced through a paper by William Philips in journal Economica. In this paper, William Philips asserted that there is an inverse relationship between 1) Unemployment and 2) Increasing nominal wages. This means that whenever nominal wages increase, unemployment, in an economy, decreases. This concept was further developed by Paul Samuelsson and other economists and it was asserted on its basis that there is an explicit/evident link between inflation and employment. The original concept of Philip’s curve is associated with the Keynesian school of thought, as it Philip’s curve claim that changes in nominal variables can bring change in real economic factors, such as employment. This relationship can be understood by the figure below (Forder).
Inflation Data. Philips Curve. Digital Image. Inflation Data. Inflation Data, 1 April 2013. Web. 1 January 2018.
This figure suggests that trade-off between unemployment and inflation only exists in the short run and but not in the long run, which makes it a new-classical and neo-Keynesian concept. When unemployment is at the natural rate of unemployment, at this point, neither inflation nor an increase in nominal wages can impact unemployment. This is an interesting finding, which is in conformity with both classical and Keynesian concepts.
2-Consider a theoretical equilibrium in a closed economy. What is the effect of an expansionary fiscal policy on both the short and the long run? Discuss its effect on the unemployment.
Development and use of the fiscal instrument are Keynesian concepts. This concept was introduced in order to mitigate the ramifications of The Great Depression. When a government uses the fiscal instrument, it increases government expenditure and reduces taxes, in order to generate employment and increase consumption, which is considered an engine of economic growth. In a closed economy, which discourages trade when the fiscal instrument is used, during the recessionary conditions, in the short run, it increases employment, consumption, and general price level. However, if an economy is in equilibrium, use of fiscal policy will inflate the interest rate because of the Crowding-Out effect. This will also reduce the level of investment in an economy, as fewer people will invest in the economy. In the short-run, there could be some impact on overall output and employment; however, in the long run, there will not impact in real factors/variables such as employment and output; however, interest rates will inflate.
Figure below explains consumption, output and price in both short and long run.
Pettinger, Tejvan. Impact of Fiscal Policy. Digital Image. Economic Help. Economic Help, 10 December 2017. Web. 1 January 2018.
3- Why does Milton Friedman put this analysis into question? To which extent is this analysis consistent with the conclusions of classical economics?
Classical Economists are of the view that changes in nominal values, factors, or variables do not bring any real change in values. For instance, it has been asserted by the Friedman that when nominal wages increase, consumption also increases, which increases the general price level, which suggests that there is no real change in real income. The nominal changes slowly adjust to real changes and the decrease in the unemployment will be for a short span. In addition, to decrease unemployment, a higher rate of inflation will be required; this decline in unemployment will be for a shorter period. However, Milton Friedman admits that there is a valid and provable relationship between inflation rate and unemployment along with changes in nominal wage (Phelan).
4-Robert Lucas improved the critics of Friedman. How?
Robert Lucas is of the view that historical data, of particular variables, is not enough to rightly predict the outcome. In the context of Phillips Curve, Robert Lucas asserts that negative relationship, between unemployment and inflation, should not only be the mean or method to address the issue of unemployment, which is one of the major concerns of the contemporary economy. There are several strategies and methods to achieve the same results, in a more systematic and logical manner. He further states that when high inflation is used as an instrument to meet the objective of low unemployment, this influence forecast of firms, companies, and organizations, which operate in the corporate or economic system, regarding inflation. This impacts their decisions regarding hiring or employment, which seriously impacts short-run unemployment (Lucas and Rapping).
REAL ECONOMIC ANALYSIS
1-Calculate the Real GDP for the two countries.
In the provided data, we have data sub-sets of Consumer Price Index, which can be used to calculate Real Gross Domestic Product. Gross Domestic Product is the whole number of final goods and services, which are produced by an economy, within a given year. Nominal GDP is not inflation adjusted, which is why it can be misleading, whereas the Real GDP is inflation adjusted, which is why it is more used to understand the health and strength of an economy. To measure REAL GDP, we have simply divided Nominal GDP with the base year value of CPI. For this assignment the base value of CPI, which we have selected, it is of the year 1984.
| Year | RGDP France (Base Year is 1984) | RGDP US (Base Year 1984) |
| 1980 | 11.2346 | 27541.5412 |
| 1981 | 9.8905 | 30894.1818 |
| 1982 | 9.3885 | 32184.1956 |
| 1983 | 8.9863 | 35004.5221 |
| 1984 | 8.5050 | 38877.9310 |
| 1985 | 8.9035 | 41822.6165 |
| 1986 | 12.3495 | 44164.2693 |
| 1987 | 14.9329 | 46859.0342 |
| 1988 | 16303.4942 | 50538.5681 |
| 1989 | 16381.5862 | 54435.5498 |
| 1990 | 20272.2737 | 57532.7374 |
| 1991 | 20309.4588 | 59403.8948 |
| 1992 | 22360.3608 | 62918.1781 |
| 1993 | 21101.8365 | 66183.9839 |
| 1994 | 22275.7517 | 70321.2647 |
| 1995 | 25566.0166 | 73740.2942 |
| 1996 | 25566.8292 | 77936.2666 |
| 1997 | 23128.9615 | 82827.1579 |
| 1998 | 23905.4282 | 87451.7718 |
| 1999 | 23701.3164 | 92999.3361 |
| 2000 | 21619.1126 | 99003.4445 |
| 2001 | 21769.1045 | 102231.9667 |
| 2002 | 23682.2851 | 105646.9071 |
| 2003 | 29183.2277 | 110766.3110 |
| 2004 | 33453.2748 | 118124.4167 |
| 2005 | 34784.1053 | 125998.7203 |
| 2006 | 36694.3280 | 133334.9369 |
| 2007 | 42029.9691 | 139323.8914 |
| 2008 | 46239.4117 | 141632.1091 |
| 2009 | 42686.2669 | 138723.5046 |
| 2010 | 41765.3502 | 143922.5270 |
| 2011 | 45258.5893 | 149459.9886 |
| 2012 | 42461.6772 | 156298.5289 |
When we compare these values, of Real GDP, with the values of Nominal GDP, we learn that there is the immense difference between that two. The inflated values of Nominal GDP are in huge size and they give the impression that an economy is of immense size.
2-Discuss the evolution of the French and US economies (hint: study trends, cycles, and turning point
From the above diagram, of the Real GDPs of the United States and France, we learn that the United States’ economy has remained quite stable for a longer period of time, whereas France’s economy could not grow at the same pace and neither had it remained stable, which impacted other macroeconomic variables.
When we study the United States and France’ unemployment data, with the help of graphs, we learn that the unemployment rate’s trend has remained very similar; however, the size of the unemployment rate is apparently different; France has a higher rate of unemployment during the same periods.
From the study of Inflation data, available in the form of Consumer Price Index, we learn that Consumer Price Index values have swelled with the passage of time. However, France’s economy has inflated less in comparison to the United States’ economy, which reason could be a high rate of consumption between the countries/
3- Study the relation between the investment and the interest rates. What can you conclude about the theoretical relation we studied?
From the study of the literature, we know that there is a negative relationship between interest rates and investment, which implies that whenever interest increases, the size of investment in economy decreases and whenever interest rate decreases the size of the investment increases.
The test, which we have used to understand this relationship, is a simple linear regression, which suggests that there is no significant relationship between the two variables. The model is not the best of models, as we can see that value of adjusting R-Square is less. Reasons could be heteroscedasticity in our data. Therefore, we must acquire better data to understand the relationship.
4- Study the relation between the inflation and the unemployment. What can you conclude from the theoretical relation we studied?
Again we learn that model, which we have devised for this regression test is not the best of models, which suggests that there is some issue with data, which we have retrieved from this test. The adjusted R-value is very small, and also our P-value is very high, which is why we are unable to explain this relationship based on the data sets we have.
Work Cited
Forder, James. Macroeconomics and the Phillips Curve Myth. Oxford University Press, 2014.
Lucas, Robert E and Leonard A Rapping. “Price expectations and the Phillips curve.” The American Economic Review 59.3 (1969): 342-350.
Phelan, John. “Milton Friedman and the rise and fall of the Phillips Curve.” The Commentator. The Commentator, 23 October 2012. Web. 1 January 2018. http://www.thecommentator.com/article/1895/milton_friedman_and_the_rise_and_fall_of_the_phillips_curve.
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