Important Economic Concepts

Phillips Curve
Two goals of economic policymakers are low inflation and low unemployment, but often these goals conflict. Suppose, for instance, that policymakers were to use monetary or fiscal policy to expand aggregate demand. This policy would lead to higher output and a higher price level. Higher output means lower unemployment, because firms need more workers when they produce more. A higher price level means higher inflation. Thus, when policymakers move the economy up, they reduce the unemployment rate and raise the inflation rate. Conversely, when they contract aggregate demand and move the economy down, unemployment rises and inflation falls. This tradeoff between inflation and unemployment, called the Phillips curve.
The Phillips curve is named after New Zealand–born economist A. W. Phillips. In 1958 Phillips observed a negative relationship between the unemployment rate and the rate of wage inflation in data for the United Kingdom.

Sacrifice Ratio
The sacrifice ratio, is the percentage of a year’s real GDP that must be forgone to reduce inflation by 1 percentage point. A typical estimate is about 5: for every percentage point that inflation is to fall, 5 percent of one year’s GDP must be sacrificed.

GDP Deflator
The GDP deflator, also called the implicit price deflator for GDP, is defined as the ratio of nominal GDP to real GDP:
GDP Deflator = (Nominal GDP/ Real GDP)
Nominal GDP measures the value of the output of the economy at current prices. Real GDP measures output valued at constant prices. The GDP deflator measures the price of output relative to its price in the base year.

Okun’s Law
Okun’s law says that a change of 1 percentage point in the unemployment rate translates into a change of 2 percentage points in GDP. Therefore, reducing inflation by 1 percentage point requires about 2.5 percentage points of cyclical unemployment.

Natural rate of unemployment
The average rate of unemployment around which the economy fluctuates. The natural rate is the rate of unemployment toward which the economy gravitates in the long run, given all the labor-market imperfections that impede workers from instantly finding jobs. (Prof. S.MAITRA, JULY,2010)