Stabilisation Policy in a Closed Economy Author(s): A. W. Phillips ...

308 TH:E ECONOMIC JOURNAL [JUNE
low, the rate of fall being greater, the lower the level of demand
and production.
We may therefore postulate a relationship between the level
of production and the rate of change of factor prices, which is
probably of the form shown in Fig. 11, the fairly sharp bend in
the curve where it passes through zero rate of change of prices
being the result of the greater rigidity of factor prices in the
downward than in the upward direction. The relationship
between the level of production and the rate of change of product
prices will be of a similar shape if productivity is constant. In
Rate of
change of
prices
FIG. 1 1
Level of
production
spite of the marked curvature of the relationship, linearity may
be assumed as an approximation for small changes in production.
If the desired level of production is now taken to be that which
would result in a constant level of product prices, we may say
that the rate of change of product prices will be approximately
proportional to the deviation of production from this level, i.e.,
to the error in production, this approximation being better, the
smaller the fluctuations which occur in production.
2. Additional Relationships when Prices and Interest Rates are
Flexible
The model used in Section I can now be extended by dropping
the assumption of constant prices and interest rates. The com-
plete model is shown diagrammatically in Fig. 12, which is the
same as Fig. 10 excepting for the addition of the group of relation-
ships in the centre of the diagram. Four additional sequences
can be distinguished.
(i) A deviation of production from the desired level will be
accompanied by a change in the number of transactions and so
a change in the amount of money needed for conducting them,
even if prices are rigid. If the quantity of money is less than
perfectly elastic, this will cause interest rates, i, to change in the
same direction 1 as the error in production. As a result of this
1 Provided that the liquidity preference schedule does not shift.