Download - © 2007 Thomson South-Western Phillips Curve. © 2007 Thomson South-Western The Phillips Curve Phillips Curve (PC)– relationship between Inflation and Unemployment.

© 2007 Thomson South-Western

Phillips Curve


The Phillips Curve

Phillips Curve (PC)–

• relationship between Inflation and Unemployment

Short Run Phillips Curve


The Phillips Curve

Deflation + extremely high UE rates = PC below the x axis (negative)


The Phillips Curve

CH

UnemploymentRate (percent)

0

InflationRate

(percentper year)

Phillips curve

4

B6

7

A2

Copyright © 2004 South-Western


Long Run Phillips Curve (LRPC)

• LRPC is at the Natural Rate of Unemployment


The Long-Run Phillips Curve

UnemploymentRate

0 Natural rate ofunemployment

InflationRate Long-run

Phillips curve

BHighinflation

Lowinflation

A

2. . . . but unemploymentremains at its natural ratein the long run.

1. When the Fed increases the growth rate of the money supply, the rate of inflation increases . . .



How the Phillips Curve is Related to Aggregate Demand and Aggregate Supply

Quantityof Output

Natural rateof output

Natural rate ofunemployment

0

PriceLevel

P

Aggregatedemand, AD

Long-run aggregatesupply

Long-run Phillipscurve

(a) The Model of Aggregate Demand and Aggregate Supply

UnemploymentRate

0

InflationRate

(b) The Phillips Curve

2. . . . raisesthe pricelevel . . .

1. An increase in the money supplyincreases aggregatedemand . . .

AAD2

B

A

4. . . . but leaves output and unemploymentat their natural rates.

3. . . . andincreases theinflation rate . . .

P2B



Expectations

• Expected inflation measures how much people expect the overall price level to change.


How Expected Inflation Shifts the Short-Run Phillips Curve

UnemploymentRate

0 Natural rate ofunemployment

InflationRate Long-run

Phillips curve

Short-run Phillips curvewith high expected

inflation

Short-run Phillips curvewith low expected

inflation

1. Expansionary policy movesthe economy up along the short-run Phillips curve . . .

2. . . . but in the long run, expectedinflation rises, and the short-run Phillips curve shifts to the right.

CB

A



Supply Shocks and the PC

• A supply shock is an event that directly alters the firms’ costs, and, as a result, the prices they charge.

• This shifts the economy’s aggregate supply curve. . .

• . . . and as a result, the Phillips curve.


An Adverse Shock to Aggregate Supply

Quantityof Output

0

PriceLevel

Aggregatedemand

(a) The Model of Aggregate Demand and Aggregate Supply

UnemploymentRate

0

InflationRate

(b) The Phillips Curve

3. . . . andraises the price level . . .

AS2 Aggregatesupply, AS

A

1. An adverseshift in aggregate supply . . .

4. . . . giving policymakers a less favorable tradeoffbetween unemploymentand inflation.

BP2

Y2

PA

Y

Phillips curve, PC

2. . . . lowers output . . .

PC2

B
