The Phillips Curve

A.P. Macroeconomics

Ms. McRoy

“Aim” What is the trade-off between inflation and

unemployment in the short-run? In the long-run?

“Do-Now”

Imagine that the economy is operating at E1, but then begins to slide into a recession as a result of decreased consumer confidence. Graph the effect of this change. What is the effect on unemployment? What is the effect on aggregate price level?

Aggregate Price Level

Real GDP (Y)

PE

YE

E1

SRASLRAS

AD

Building the Short-run Phillips Curve

Qf

Price Level

Y

PE E1

SRAS

LRAS

AD

QIQR

AD2

P1

Q1

AD1

E2

Q2

E3P2

Inflation Rate

PE a

SRPC

P1

u1 u2

b

Unemployment Rate

u3

P2 c

Building the Short-run Phillips Curve

Qf

Price Level

Y

PE E1

SRAS

LRAS

AD

QIQR

P1

Q1

E2

Q2

E3P2

Inflation Rate

PE a

SRPC

P1

u1u2

b

Unemployment Rate

u3

P2 c

SRAS1

SRAS2

SRPC1

SRPC2

The Long-run Phillips Curve

0%a

SRPC0

5%Unemployment Rate

Phillips CurveInflation Rate

Suppose now, that the government passes an expansionary fiscal policy…

What happens to unemployment and inflation?

3%

2%b

SRPC1

c

LRPC

NAIRU

NAIRU Proposed by Milton Friedman (Monetarist) The non-accelerating inflation rate of

unemployment (NAIRU) – the unemployment rate at which inflation does not change over time. Keeping unemployment below NAIRU leads to

accelerating inflation and cannot be maintained.

Keeping unemployment above NAIRU leads to decelerating inflation.

“Aim” What is the trade-off between inflation and

unemployment in the short-run? In the long-run?