LRAS Review

1

Handout for Review: You may work together

2

The Phillips CurveShows tradeoff between inflation and

unemployment.What happens to inflation and unemployment

when AD increase?

4

In general, there is an inverse relationship between unemployment and inflation

Inflation

5

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

6

SRPC

Short Run Phillips Curve

Unemployment2% 9%

1%

5%

What happens when AS falls causing stagflation?Increase in unemployment and inflation

SRPC1

Inflation

7

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

8

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

9

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

11

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

12

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

13

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

14

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?

15

Price Level

16

SRAS

GDPRQY

LRAS Inflation

SRPC

UnemploymentUY

LRPC

AD

Price Level

17

SRAS

GDPRQY

LRAS Inflation

SRPC

UnemploymentUY

LRPC

AD2

AD3

PLe

AD

Price Level

18

SRAS

GDPRQY

LRAS Inflation

SRPC

UnemploymentUY

LRPCAS1

PLe

AS2

SRPC1

SRPC2

AD

Price Level

19

AS

GDPRQY

LRAS Inflation

SRPC

UnemploymentUY

LRPCAS2

PLe

SRPC1AD2

Do you remember the wage-price-spiral?

20

21

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

22

Review of the Phillips Curve

23