Phillips curve

• Phillips curve

  A model that shows the relationship between inflation and unemployment
• The Phillips curve is useful for showing demand-pull inflation, cost-push inflation, and long-term equilibrium using the classical model
• The Phillips curve is unlikely to be asked about directly on an exam, but can be used to demonstrate concepts like the conflict between inflation and unemployment
• Short-run Phillips curve (SRPC)

  Shows the inverse relationship between wage growth and unemployment
• Phillips was a New Zealand economist who developed the Phillips curve in the late 1950s/early 1960s
• Economists later changed the Phillips curve to show the relationship between inflation and unemployment instead of wage growth and unemployment
• Short-run Phillips curve

  Shows the conflict between low unemployment and low inflation - policymakers must choose between the two
• Deriving the short-run Phillips curve from the classical model

  1. Start at full employment with low inflation

  2. Shift AD to the right to increase growth and reduce unemployment

  3. But this increases inflation

  4. Shift AD to the left to reduce inflation

  5. But this increases unemployment
• The short-run Phillips curve does not explain periods of stagflation (high inflation and high unemployment)
• Adapting the short-run Phillips curve to explain stagflation

  1. Negative supply shock shifts SRAS to the left

  2. This increases both inflation and unemployment

  3. The SRPC shifts to the right to show stagflation
• Positive supply shocks can also be shown on the adapted short-run Phillips curve, shifting it to the left and showing lower inflation and lower unemployment
• The short-run Phillips curve still has limitations as it does not show long-term equilibrium, which the classical model can
• Monetarists further adapted the Phillips curve model to address its limitations
• Long run Phillips curve


  Shows that in the long term, output will always return to the Full Employment level
• You need to watch the previous video on the short run Phillips curve to understand the long run Phillips curve
• Deriving the long run Phillips curve from the classical model

  1. Increase in AD

  2. Increase in output from YF to Y2

  3. Increase in demand for inflation

  4. Movement up the Phillips curve

  5. Increase in inflation to 3% and reduction in unemployment to 3%

  6. Workers change wage expectations and demand higher wages

  7. Increase in cost-push inflation

  8. Shift of SRAS to the left

  9. Shift of short-run Phillips curve to the right

  10. Movement to point C with inflation at 4% and unemployment at natural rate
• Long run Phillips curve

  Tells us that output will always return to the natural rate of unemployment, where all factors of production are being used to the maximum amount but at sustainable levels
• Non-accelerating inflation rate of unemployment (NAIRU)

  The unemployment rate at which the inflation rate can be stable and non-accelerating
• Increase in AD in the classical model

  Leads to movement up the short-run Phillips curve, but in the long run the economy will return to the natural rate of unemployment
• Decrease in AD in the classical model

  Leads to movement down the short-run Phillips curve, and then a shift of the Phillips curve to the left, but the economy will still return to the natural rate of unemployment
• Long run Phillips curve

  • Complements classical ideas and classical models
  • The only way to reduce the natural rate of unemployment and achieve sustainable growth in the long term is through supply-side policies that shift the long run Phillips curve to the left
• Draw a Phillips curve

  
• LR Phillips Curve