In the new classical model, the upward-sloping short-run Phillips curve can be brought about by supply-side factors, specifically the influence of inflation expectations and adaptive wage-setting behavior.
Inflation Expectations: In the new classical model, individuals form rational expectations about future inflation. If they anticipate higher future inflation, workers and firms will adjust their behavior accordingly. Workers will demand higher wages to compensate for the expected inflation, and firms will pass on these higher costs to consumers in the form of higher prices. As a result, an increase in inflation expectations leads to an upward shift in the short-run Phillips curve.
Adaptive Wage-Setting Behavior: Adaptive wage-setting refers to the idea that wages adjust gradually in response to changes in market conditions. If there is a temporary increase in demand or a supply shock, firms may respond by increasing output and employment in the short run. However, due to adaptive wage-setting behavior, wages do not immediately adjust to reflect these changes. As a result, workers experience a temporary increase in real wages, leading to higher production costs and upward pressure on prices. This leads to an upward-sloping short-run Phillips curve.
Diagrammatically, the upward-sloping short-run Phillips curve can be represented as follows:
In this diagram, the vertical axis represents the inflation rate (π), and the horizontal axis represents the unemployment rate (u). The short-run Phillips curve is upward-sloping, indicating that there is a positive relationship between inflation and unemployment in the short run. This reflects the trade-off between inflation and unemployment suggested by the Phillips curve.