Suppose that unemployed workers expect inflation to be 10 percent, but inflation actually turns out to be 12 percent. If the workers do not revise their reservation wages and wage offers are in line with the actual inflation rate, then a movement up the short-run Phillips curve should take place.

Question

Quizplus · Accepted Answer

If workers do not revise their reservation wages and wage offers adjust to the actual inflation rate, then the natural rate of unemployment would be higher than the short-term level. This creates a positive short-run Phillips curve, which shows that there's a trade-off between inflation and unemployment. As inflation is higher than expected, workers would demand higher wages, and firms would tend to reduce employment, which leads to higher unemployment. This would result in an upward movement along the short-run Phillips curve.

Suppose That Unemployed Workers Expect Inflation to Be 10 Percent