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.

CONTROVERSEY: 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.

RULES If AD shifts = movement along SRPC If SRAS shifts = SRPC shifts in opposite direction If LRAS shifts = LRPC shifts in opposite direction

LR vs. SR Phillips Curve??? LRPC SRPC Remind you of something? 5% What is the unemployment rate?

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

LRPC SRPC 5% What Could Cause LRPC to Shift?