The original Phillips curve and the trade-off

The Phillips curve shows an inverse relation between unemployment and inflation: where unemployment is high, inflation is low, and where unemployment is low, inflation is high (CUET 2019, 2021, 2026; Hyderabad 2013; JNU 2021). It was first fitted to the rate of change of money wages (Hyderabad 2011), and the price version came afterwards. The vertical axis is inflation and the horizontal axis is the unemployment rate, so the curve slopes down to the right.

Keep it apart from the curve that links output and unemployment, which is Okun’s law (Lesson 6): the Phillips curve relates unemployment to inflation (UGC NET 2025 matching list).

The explanation runs through the labour market. When unemployment is low, workers are scarce: unions bargain harder and firms bid wages up to keep and attract staff, so wages rise quickly. When unemployment is high the bargaining power of the unions falls and wages rise slowly or not at all (CUET 2024, the opening question). Firms pass the higher wage bill into prices. So a tight labour market means rising costs and rising prices (Hyderabad 2020).

That is also why the curve is described as the link between the goods market and the labour market (Hyderabad 2021): unemployment is the state of one, inflation the state of the other.

Phillips fitted wages; the exams and policymakers care about prices. The bridge is how firms set prices. If a firm charges a constant mark-up μ over its unit labour cost, wage per worker divided by output per worker, then P = (1 + μ)W/A. In growth rates, prices rise by the rise in wages less the rise in productivity:

The rest of the module works with the price version, π against u, and treats the wage story as the reason it slopes down.

This is the first appearance of the Dial, which comes back in later lessons. You are a policymaker with one dial: the unemployment rate you will hold the economy at. Turn it and read the inflation you buy. Here expectations never move, so the curve is fixed and the same point is available every year: the menu of the original curve.

Almost every question on this curve tests one of four things.

• A move along it. A change in demand, with expectations held constant, moves the economy along the curve. If aggregate demand falls unexpectedly, prices fall and unemployment rises (IIT JAM 2024). The statement “a fall in unemployment lowers wage and price inflation” has the direction backwards: it is the rise in unemployment that does that (CUET 2022).
• A shift of it. Something that raises unemployment at every rate of inflation shifts the curve to the right. A sudden inflow of unemployed immigrants is the standard example (JNU 2017).
• Where it meets the axis. The point where the curve meets the unemployment axis, where inflation is zero, is read as the natural rate of unemployment (JNU 2016). That reading holds when expected inflation is zero; Lesson 7 says why.
• Matching it to its neighbours. Phillips curve: unemployment and inflation. Okun’s law: unemployment and output. Laffer curve: tax revenue and the tax rate. J-curve: devaluation and the trade balance (CUET 2023, UGC NET 2025, GATE 2025).

Read the Dial’s menu naively and 3% unemployment looks permanently available at 4% inflation. Nothing in the original curve says what happens if the economy stays there. The argument made by Phelps and Friedman in the late 1960s was that it does not: workers who see prices rising year after year ask for more, and the curve moves. That is Lesson 7.