Question: The Phillips curve is based on the observed negative relation between the rate of inflation and the unemployment rate. That is, decreases in the unemployment

The Phillips curve is based on the observed negative relation between the rate of inflation and the unemployment rate. That is, decreases in the unemployment rate tend to be associated with increases in the rate of inflation.

a) Given what you know about the relation between the unemployment rate and the GDP gap, restate the Phillips curve in terms of inflation and the GDP gap.

b) Based on the AD-IE model, and given your answer in (a), explain why the Phillips curve is not likely to be stable over time. Why is it that trying to lower the unemployment rate below its full-employment level results in higher inflation?

c. Using the AD-IE model, explain how a condition of stagflation—rising inflation and a negative GDP gap—falsifies the underlying principle of the Phillips curve.

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