PHILLIPS CURVE
PHILLIPS CURVE
• As fiscal policies are used to eliminate
unemployment, there comes a point where
additional reductions in unemployment
create more and more inflation. (text: 764)
• In the long run, there is no tradeoff b/c the
economy is at full employment. So any policy
that would increase aggregate demand
would not create more employment, but only
greater inflation. (Text 768-9) Think of AD/AS
self correcting .
• CONTROVERSY:
• During the 1970’s, inflation and
unemployment increased at the same time,
resulting in stagflation. By 1975,
unemployment was at 8.5% and inflation
hitting highs. (again in the early 80’s :
unemployment 9.5%)
• It became clear that high unemployment did
not ensure low inflation, and high inflation
did not ensure low unemployment.
Practice
• a. Draw AD/AS model w/ recessionary gap.
Draw a short run Phillips curve side by side.
• b. Identify 2 fiscal policies that would be used
• c. adjust your AD/AS graph based on your
answer to part b.
• d. show how the change in AD/AS would
affect the Phillips curve.
• e. explain the changes and effects from parts
c and d.
LR vs. SR Phillips Curve???
LRPC
Remind you of
something?
SRPC
What is the
unemployment
rate?
5%
1. A. Show the economy in equilibrium side by
side with SRPC.
B. Show the move to stagflation.
C. Show the corresponding change on the SRPC
2. A. Show the economy in equilibrium side by
side with SRPC.
B. Show SRAS shift right .
C. Show the corresponding change on the SRPC
What Could Cause LRPC to Shift?
LRPC
SRPC
5%
RULES
• If AD shifts = movement along SRPC
• If SRAS shifts = SRPC shifts in opposite
direction
• If LRAS shifts = LRPC shifts in opposite
direction