This Exercise Uses an Aggregate-Supply Curve and a Production Function

Essay

This exercise uses an aggregate-supply curve and a production function to construct the corresponding Phillips curve. Its purpose is to better understand the assumptions behind the short-run Phillips curve. Suppose the aggregate production function of an economy is Y=L, where Y is output and L is labour (employment). Unemployment is U=LF-L, and the unemployment rate is u = U/LF. We also need to assume that the labour force (LF) is constant, such that an increase in the number of employed people (ÄL) corresponds to an equal decrease in the number of unemployed (-ÄU). Let us assume a very simple-short run aggregate supply curve, Y=P. Question: For the price levels P equal 100, 105, and 115, find two inflation-unemployment points in a Phillips curve diagram. Consider LF=120.