Phillips curve analysis attracted considerable interest from the policy makers, particularly because of its implications of the relationship for price inflation.
Price-level changes were first linked to money wage rate changes so that Phillips curve expressed the inverse relationship between the rate of price inflation and the rate of unemployment.
Policy-makers interpreted Phillips curves as a trade-off between price inflation and unemployment.
Thus, a stable Phillips curve enables the policy-makers to choose a given rate of unemployment (or inflation) and bear the cost of a necessary rate of inflation (or unemployment).
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In other words, less inflation can be had only at the cost of higher unemployment or lower unemployment can be had at the cost of higher inflation.
This has been drawn by displacing downward the original Phillips curve by a vertical distance equivalent to the constant rate of productivity growth.
Similarly, a lower unemployment rate can be achieved only at a positive rate of inflation. Thus in order to be practically useful, the position, the form and the stability of the Phillips curve are very important
The problem of choosing the optimum inflation-unemployment combination can be analysed with the help of indifference curve technique.
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It is assumed (a) that the policy-maker is prepared to exchange some increase in the rate of inflation for a reduction in the unemployment rate and (b) that he possesses a preference function represented in a set of indifference curves.
Since, both inflation and unemployment are undesirable goods, the indifference curves are assumed to be concave to the origin and the higher utility is attained by moving towards the origin.
So long as there exists a stable permanent Phillips curve, it indicates that a permanent decrease in unemployment rate can be purchased for a permanent increase in the rate of inflation.
But, beginning in the late 1960’s, increasing doubts about the stable Phillips curve have appeared and various shift parameters have been introduced in the analysis.
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In such a situation, when the Phillips curve is used for policy formulation, it is very important to take into consideration the slope and the position of the Phillips curve.
The slope of the Phillips curve tells the rate at which unemployment can be traded off against inflation. The position of the Phillips curve tells the initial magnitude of the unemployment-inflation relationship.