Post on 19-Jan-2016
Handout for Review: You may work together
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The Phillips CurveShows tradeoff between inflation and
unemployment.What happens to inflation and unemployment
when AD increase?
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In general, there is an inverse relationship between unemployment and inflation
Inflation
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SRPC
Short Run Phillips Curve
Unemployment2% 9%
1%
5%
When the economy is overheating, there is low unemployment but high inflation
When there is a recession, unemployment is high but
inflation is low
Inflation
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SRPC
Short Run Phillips Curve
Unemployment2% 9%
1%
5%
What happens when AS falls causing stagflation?Increase in unemployment and inflation
SRPC1
Inflation
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SRPC
Short Run vs. Long Run
Unemployment2% 9%
1%
5%
What happens when AD increases?
SRPC1
3%
5%
Long Run Phillips Curve
In the long run, wages and resource prices increase. AS falls.
SRPC shifts right.
What happens in the long run?
Inflation
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Short Run vs. Long Run
Unemployment2% 9%
1%
5%
3%
5%
Long Run Phillips Curve
In the long run there is no tradeoff between inflation and unemployment
The LRPC is vertical at the Natural Rate of
Unemployment
Inflation
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SRPC
Short Run vs. Long Run
Unemployment2% 9%
1%
5%
What happens when AD falls?
SRPC1
3%
5%
Long Run Phillips Curve
In the long run wages fall and there is no tradeoff between
inflation and unemployment
What happens in the long run?
AD/AS and the Phillips Curve
Price Level
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AD
AS
AD/AS and the Phillips Curve
GDPRQY
PLe
LRAS Inflation
SRPC
UnemploymentUY
LRPC
Show what happens on both graphs if AD increase
AD1
Price Level
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AD
AS
AD/AS and the Phillips Curve
GDPRQY
PLe
LRAS Inflation
SRPC
UnemploymentUY
LRPC
Correctly draw the LRPC and SRPC with the recessionary gap. What happens when AD falls?
AD1
Price Level
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AD
AS
AD/AS and the Phillips Curve
GDPRQY
PLe
LRAS Inflation
SRPC
UnemploymentUY
LRPC
Correctly draw the LRPC and SRPC at full employment. What happens when AS falls?
AS1
SRPC1
Price Level
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AD
AS
AD/AS and the Phillips Curve
GDPRQY
PLe
LRAS Inflation
SRPC
UnemploymentUY
LRPC
Correctly draw the LRPC and SRPC with an recessionary gap. What happens when AS goes up?
AS1
SRPC1
Can you see it?
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Price Level
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SRAS
GDPRQY
LRAS Inflation
SRPC
UnemploymentUY
LRPC
AD
Price Level
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SRAS
GDPRQY
LRAS Inflation
SRPC
UnemploymentUY
LRPC
AD2
AD3
PLe
AD
Price Level
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SRAS
GDPRQY
LRAS Inflation
SRPC
UnemploymentUY
LRPCAS1
PLe
AS2
SRPC1
SRPC2
AD
Price Level
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AS
GDPRQY
LRAS Inflation
SRPC
UnemploymentUY
LRPCAS2
PLe
SRPC1AD2
Do you remember the wage-price-spiral?
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The Good, the Bad, and the Ugly
Unemployment Inflation GDP Growth
Good 6% or less 1%-4% 2.5%-5%
Worry 6.5%-8% 5%-8% 1%-2%
Bad 8.5 % or more 9% or more .5% or less
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Review of the Phillips Curve
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