If you're seeing this message, it means we're having trouble loading external resources on our website.

If you're behind a web filter, please make sure that the domains *.kastatic.org and *.kasandbox.org are unblocked.

Main content
Current time:0:00Total duration:8:47
MOD‑3 (EU)
MOD‑3.A (LO)
MOD‑3.A.1 (EK)
MOD‑3.A.2 (EK)

Video transcript

in the late 1950s William Phillips noticed a correlation between unemployment and inflation and I'd have a picture of this gentleman right over here Irving Fisher because he actually noticed that a relationship a few decades before but the relationship has taken on Phillips's name really because his publication kind of captured people's imagination and the relationship is not that surprising it seems to fall a little bit out of common sense but we'll talk about examples that seem to go against this relationship if I were to plot if I were to plot the unemployment percentage right over here unemployment unemployment percentage on my horizontal axis and I plot inflation on my vertical axis so let me put inflation here inflation on my vertical axis then he noticed and I'm just going to pick random data points that it but in one year where there was high inflation there was low unemployment and then in another year where there was high unemployment there was low inflation and it's not clear which one is causing which or maybe they both circle back on each other and then in other years maybe where you had medium medium inflation or relatively low you had relatively low unemployment and so he looked at a bunch of years and plotted them on an axis like this so let me do them all in the same color so you take a bunch of years and you plot them here so now you have higher inflation slightly higher employment unemployment then that year over there and I could just keep plotting keep plotting some points over here you could even have deflation and what he saw is there's a correlation here that there's an inverse relationship that if you were to try to fit a curve to these points and you could have more points here and I'm just picking them as random you could fit a curve that looks something like this you could fit a curve that looks something like this there's generally saying that when you have high inflation so that's up here so when you up here you have high inflation low unemployment high inflation and low unemployment low unemployment unemployment which is the low unemployment part is a good thing and out here out here you have low inflation low inflation and high unemployment high and Eve if this curve goes below the horizontal axis you could actually have deflation high high unemployment and it makes I think reasonable sense we've kind of talked about it in common-sense terms before but you could imagine and once again it's not clear which one's causing which but you could imagine in a world just reasoning through it that if you have low unemployment or you could view that as high employment low unemployment one way to view low employment is that you have high utilization of the labor market well now in this situation workers have more leverage workers workers have have more leverage and if workers have more leverage then employers will what will have to increase wages to attract and retain employers so they have more leverage and they have more options there are a lot of people looking to hire them employers so let me think of it from the employers employers employers raise wages raised wages to attract and retain employees attract and retain employees but of course when you increase wages you are increasing buying power generally for workers so this is this is increasing workers buying power increasing increasing buying power which would increase their demand so this is going to increase their demand for goods and services and if they're increasing the demand for goods and services it's going to increase the utilization of all of the factors of production of land of capital of entrepreneurship and of labor and so that's going to lower unemployment even more and you could imagine if you already have low unemployment or and this is just one of the factors of production but you think about all the factors of production they're probably all highly utilized the factories are running it close to full capacity you're the the labor market is running at full capacity if you increase buying power you increase demand in that context so demand is going up demand is going up lower unemployment capacity utilization or I guess you say labor utilization is going down there's less capacity more demand this is going to cause prices to go up so this is going to cause prices generally prices to go up and then if prices go up now workers have leverage and options when the low unemployment but they also have higher costs so then we'll also say workers have higher costs higher cost of living cost of living and this is a very kind of hand wavy diagram and it's just to make you think about the overlong dynamics and so workers have more options and leverage they also have a higher cost of living the whole the whole economy is kind of operating it close to Full Tilt and so they're going to demand higher wages even more and then this thing can keep cycling and keep cycling now this seems a bit common-sense but there are exceptions to these in the 1970s the United States experienced stagflation and that's kind of the worst of both worlds that's high inflation and high unemployment so that is right over here and things that could cause it and in particular what people point to in the 1970s and it's always important to realize in economics people don't know for sure what was the exact cause that therefore seldom is only one cause but one of the things that's often pointed to is that you had a supply shock you had a supply shock and the supply shock was in oil it made the cost of producing everything more expensive and so that just drove the prices up but it really didn't allow it really didn't allow the country as a whole to become more productive one way to think about it is it drove the prices up here caused a higher cost of living right over here but this part of this cycle that we would normally associate with low unemployment and low and high inflation was not occurring so this part this part right over here this part right over here was not occurring and because those higher prices were essentially going out of the country you could you get a she imagined that they were squeezing out people's ability to pay for other things so this the higher cost of the higher cost of living or the higher prices for oil you could draw a line from either one and I know it's getting messy now you could imagine that it inhibited demand it inhibited demand for domestic production so I'll draw a negative feedback right over there so it squeezed out people's desire to buy things from this because I had to pay so much for oil and there's other explanations for it when people saw the low unemployment the government wanted to print even more money to fuel things but it did not get this kind of virtual cycle happening there are some arguments that there were structural reasons why the government why the economy couldn't adapt properly so that employees or workers and resources couldn't be allocated efficiently but the whole point of bringing up the 1970s is to show you that this isn't a law and it's not clear what's causing what that there is there was a situation in the 1970s where you had stagflation and the opposite of that was what we really saw in the late 90s where you had relatively low inflation and you had relatively low unemployment so this is a very good situation that we had in the late 90s and the argument that many people make why we were able to do that why this cycle didn't keep going on and on why the prices didn't go up is that you had this other trend of huge technological improvement you had computers and telecommunications had this on the internet 100 is in this kind of super productivity curve so even though you had the cycle you had an increased buying power demand was going up the productivity of the country was increasing so much that it did not lead to inflation and so that's what threw us there in the late 90s so in general it's a neat thing to think about it's it's it's at least to some degree it seems like common sense but like in all things in economics it's always a little bit more nuanced and complicated than just some little you know some correlation that that you might observe this could be generally true but there's always going to be exceptions to it
AP® is a registered trademark of the College Board, which has not reviewed this resource.