The Phillips Curve

1

Chapter 3 Unit 35 Business, Computers,

& Information

Technology

The Phillips Curve

Shows tradeoff between inflation

and unemployment.

What happens to inflation and

unemployment when AD increase?

3

In general, there is an inverse relationship

between unemployment and inflation

Inflation

4

SRPC

Short Run Phillips Curve

Unemployment 2% 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

5

SRPC

Short Run Phillips Curve

Unemployment 2% 9%

1%

5%

What happens when AS falls causing prices to increase and output to decrease (stagflation)?

Increase in unemployment and inflation

SRPC1

Inflation

6

SRPC

Short Run vs. Long Run

Unemployment 2% 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 shifts to

the left. SRPC shifts

right.

What happens in the long run?

Inflation

7

Short Run vs. Long Run

Unemployment 2% 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

8

SRPC

Short Run vs. Long Run

Unemployment 2% 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

10

AD

AS

AD/AS and the Phillips Curve

GDPR Qf

PLe

LRAS Inflation

SRPC

Unemployment

UY

LRPC

Show what happens on both graphs if AD increase

AD1

Price

Level

11

AD

AS

AD/AS and the Phillips Curve

GDPR Qf

PLe

LRAS Inflation

SRPC

Unemployment

UY

LRPC

Correctly draw the LRPC and SRPC with the recessionary gap. What happens when AD falls?

AD1

Price

Level

12

AD

AS

AD/AS and the Phillips Curve

GDPR Qf

PLe

LRAS Inflation

SRPC

Unemployment

UY

LRPC

Correctly draw the LRPC and SRPC at full employment. What happens when AS falls?

AS1

SRPC1

Price

Level

13

AD

AS

AD/AS and the Phillips Curve

GDPR Qf

PLe

LRAS Inflation

SRPC

Unemployment

UY

LRPC

Correctly draw the LRPC and SRPC with an recessionary gap. What happens when AS goes up?

AS1

SRPC1

Price Level

14

SRAS

GDPR Qf

LRAS Inflation

SRPC

Unemployment UY

LRPC

AD

Price Level

15

SRAS

GDPR Qf

LRAS Inflation

SRPC

Unemployment UY

LRPC

AD2

AD3

PLe

AD

Price Level

16

SRAS

GDPR Qf

LRAS Inflation

SRPC

Unemployment UY

LRPC AS1

PLe

AS2

SRPC1

SRPC2

AD

Price Level

17

AS

GDPR Qf

LRAS Inflation

SRPC

Unemployment UY

LRPC AS2

PLe

SRPC1 AD2

The Laffer

Curve

Shows relationship between tax

rate and tax revenue. What would happen if the highest tax

bracket was 75%?

18

THINK ROBIN HOOD!!!!!! What was his group’s name? Merry Men What did they do? Laugh a lot…they were “Laffers.” What was his weapon of choice? Bow and Arrow What did Robin Hood do? Steal from the rich and give to the poor. What would happen to the amount of travelers through Sherwood forest if he took 95% instead of 39% of their money?

What would happen to the total amount of money he collects?

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The Laffer Curve

20

% Tax

Rate

Tax Revenue

If the government

increase taxes rates tax

revenue will increase

If the tax rate becomes

too high, tax revenue

will fall since workers

have no incentive to

work harder

n

m

l

The Debate over the Laffer Curve

• Lower taxes give

incentive to “buy more

leisure”

• Lower taxes encourage

immediate spending

increases which may

result in inflation

• Where are we on the

curve? What if we think

n but really at m?

• Lower taxes give

incentives to work

• Lower taxes

encourage eventual

savings and

investments

Supporters Critics

Where is the U.S. currently?

Analyzing the Economy

Graphically

22

Use the following models to

show full employment, a

recessionary gap, and an

inflationary gap.

1. PPC

2. Business Cycle

3. AD/AS

4. Phillips Curve

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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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