This Phillips curve formula: = π -ε (u-u*). Remember, in the labour market, nominal wage is assumed to move quickly and the labour market will always be in equilibrium. The equilibrium amount, N*, is considered to be full employment in the labour market. The unemployment rate is then considered by the following: (u-u*) = (N*-N)/N

Consider the transition period between the short run and the long run, there is no more flexible wage in the labour market. Instead, wage is sticky (slow moving). Slowly adjusting wages will lead to some unemployment rate, that is not the full employment level of the unemployment rate u*.

Ï€ = wage inflation
π = -ε(u-u*)
ε = amount of stickiness of wage adjustment

To sum up, this equation π = -ε(u-u*) measures the wage adjustment in labour market, as measured by deviations of the current unemployment rate from the full employment level of the unemployment rate, which leads to nominal wage changes.

Check the trackback comments for more info on the Phillips curve and how it’s now fashionable and yes it does exist.