Unit 3: Aggregate Demand and Supply and Fiscal Policy 1 Copyright ACDC Leadership 2015

The Phillips Curve Shows tradeoff between inflation and unemployment. What happens to inflation and unemployment when AD increase? Copyright ACDC Leadership 2015

In general, there is an inverse relationship between unemployment and inflation 3 Copyright ACDC Leadership 2015

Short Run Phillips Curve When the economy is overheating, there is low unemployment but high inflation Inflation When there is a recession, unemployment is high but inflation is low 5% Short Run -AD Falls, PL and Q fall Long Run- AS Increases as workers accept lower wages and production costs fall. PL goes down, Q goes back to Full Employment 1% SRPC 2% 9% Unemployment 4 Copyright ACDC Leadership 2015

Short Run Phillips Curve What happens when AS falls causing stagflation? Increase in unemployment and inflation Inflation 5% Short Run -AD Falls, PL and Q fall Long Run- AS Increases as workers accept lower wages and production costs fall. PL goes down, Q goes back to Full Employment SRPC1 1% SRPC 2% 9% Unemployment 5 Copyright ACDC Leadership 2015

Short Run vs. Long Run Long Run Phillips Curve In the long run there is no tradeoff between inflation and unemployment Long Run Phillips Curve Inflation 5% The LRPC is vertical at the Natural Rate of Unemployment 3% Short Run -AD Falls, PL and Q fall Long Run- AS Increases as workers accept lower wages and production costs fall. PL goes down, Q goes back to Full Employment 1% 2% 5% 9% Unemployment 6 Copyright ACDC Leadership 2015

The Phillips Curve in real life isn’t like the textbook

AD/AS and the Phillips Curve Copyright ACDC Leadership 2015

AD/AS and the Phillips Curve Show what happens on both graphs if AD increase LRPC Price Level LRAS Inflation AS PLe AD1 AD SRPC QY GDPR UY Unemployment 9 Copyright ACDC Leadership 2015

AD/AS and the Phillips Curve Correctly draw the LRPC and SRPC with the recessionary gap. What happens when AD falls? Price Level LRAS LRPC Inflation AS PLe AD SRPC AD1 QY GDPR UY Unemployment 10 Copyright ACDC Leadership 2015

AD/AS and the Phillips Curve Correctly draw the LRPC and SRPC at full employment. What happens when AS falls? Price Level LRAS LRPC Inflation AS1 AS PLe SRPC1 AD SRPC QY GDPR UY Unemployment 11 Copyright ACDC Leadership 2015

AD/AS and the Phillips Curve Correctly draw the LRPC and SRPC with an recessionary gap. What happens when AS goes up? Price Level LRAS LRPC Inflation AS AS1 PLe SRPC AD SRPC1 QY GDPR UY Unemployment 12 Copyright ACDC Leadership 2015

SRAS LRPC LRAS Price Level Inflation SRPC QY GDPR UY Unemployment 13 Copyright ACDC Leadership 2015

SRAS LRPC LRAS Price Level Inflation PLe AD2 AD SRPC AD3 QY GDPR UY Unemployment 14 Copyright ACDC Leadership 2015

AS1 SRAS LRPC LRAS Price Level Inflation AS2 PLe SRPC1 AD SRPC2 SRPC QY GDPR UY Unemployment 15 Copyright ACDC Leadership 2015

AS AS2 LRPC LRAS Price Level Inflation PLe SRPC1 AD2 AD SRPC QY GDPR UY Unemployment 16 Copyright ACDC Leadership 2015

2008 Audit Exam A

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Analyzing the Economy Graphically 19 Copyright ACDC Leadership 2015

PPC Business Cycle AD/AS Phillips Curve Use the following models to show full employment, a recessionary gap, and an inflationary gap. PPC Business Cycle AD/AS Phillips Curve Copyright ACDC Leadership 2015

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 21 Copyright ACDC Leadership 2015