According to the equation for the Phillips curve, if nominal wages rise by 8% and labor productivity rises by 5%, then we can expect

Question

Quizplus · Accepted Answer

The Phillips curve equation suggests that there is an inverse relationship between inflation (or price levels) and unemployment (or slack in the labor market). The equation is often written as: π = f(u,w), where π is the inflation rate, u is the unemployment rate, and w is some measure of nominal wages or labor costs. The equation can be rearranged to solve for the expected change in inflation as: ∆π = α∆w - β∆u, where α is the sensitivity of inflation to changes in wages, and β is the sensitivity of inflation to changes in unemployment. If we assume that β is small or negligible in the short run, then the equation simplifies to: ∆π ≈ α∆w. In other words, we can expect inflation to rise or fall by some proportion of the change in wages, depending on how much firms pass on their cost increases to consumers. If nominal wages rise by 8% and labor productivity rises by 5%, then we can assume that the unit labor cost also rises by 3% (since nominal wages increase faster than labor productivity). If firms pass on this cost increase to consumers in the form of higher prices, then we can expect inflation to rise by a similar amount. Therefore, the best choice is C, which implies that prices will rise by 3%.

According to the Equation for the Phillips Curve, If Nominal