The key feature that makes the short-run Phillips curve have a negative slope-meaning that unexpected inflation decreases the unemployment rate-is that
A) expectations are formed irrationally.
B) reservation wages are fixed.
C) workers behave irrationally.
D) firms are greedy.
E) government policy is time consistent.

Question

Quizplus · Accepted Answer

The short-run Phillips curve has a negative slope because in the short run, nominal wages are fixed or slow to adjust, and therefore, workers' reservation wages are fixed. Thus, unexpected inflation can temporarily lower the real wage, which in turn can decrease the unemployment rate as firms increase their hiring. This relationship only holds in the short run, as workers eventually adjust their expectations and wages, leading to an increase in the natural rate of unemployment.

The Key Feature That Makes the Short-Run Phillips Curve Have