LRAS Review 1

Handout for Review: You may work together 2

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

4 In general, there is an inverse relationship between unemployment and inflation

Inflation 5 SRPC Short Run Phillips Curve Unemployment 2%9% 1% 5% When the economy is overheating, there is low unemployment but high inflation When there is a recession, unemployment is high but inflation is low

Inflation 6 SRPC Short Run Phillips Curve Unemployment 2%9% 1% 5% What happens when AS falls causing stagflation? Increase in unemployment and inflation SRPC 1

Inflation 7 SRPC Short Run vs. Long Run Unemployment 2%9% 1% 5% What happens when AD increases? SRPC 1 3% 5% Long Run Phillips Curve In the long run, wages and resource prices increase. AS falls. SRPC shifts right. What happens in the long run?

Inflation 8 Short Run vs. Long Run Unemployment 2%9% 1% 5% 3% 5% Long Run Phillips Curve In the long run there is no tradeoff between inflation and unemployment The LRPC is vertical at the Natural Rate of Unemployment

Inflation 9 SRPC Short Run vs. Long Run Unemployment 2%9% 1% 5% What happens when AD falls? SRPC 1 3% 5% Long Run Phillips Curve In the long run wages fall and there is no tradeoff between inflation and unemployment What happens in the long run?

AD/AS and the Phillips Curve

Price Level 11 AD AS AD/AS and the Phillips Curve GDP R QYQY PL e LRAS Inflation SRPC Unemployment UYUY LRPC Show what happens on both graphs if AD increase AD 1

Price Level 12 AD AS AD/AS and the Phillips Curve GDP R QYQY PL e LRAS Inflation SRPC Unemployment UYUY LRPC Correctly draw the LRPC and SRPC with the recessionary gap. What happens when AD falls? AD 1

Price Level 13 AD AS AD/AS and the Phillips Curve GDP R QYQY PL e LRAS Inflation SRPC Unemployment UYUY LRPC Correctly draw the LRPC and SRPC at full employment. What happens when AS falls? AS 1 SRPC 1

Price Level 14 AD AS AD/AS and the Phillips Curve GDP R QYQY PL e LRAS Inflation SRPC Unemployment UYUY LRPC Correctly draw the LRPC and SRPC with an recessionary gap. What happens when AS goes up? AS 1 SRPC 1

Can you see it? 15

Price Level 16 SRAS GDP R QYQY LRAS Inflation SRPC Unemployment UYUY LRPC

AD Price Level 17 SRAS GDP R QYQY LRAS Inflation SRPC Unemployment UYUY LRPC AD 2 AD 3 PL e

AD Price Level 18 SRAS GDP R QYQY LRAS Inflation SRPC Unemployment UYUY LRPC AS 1 PL e AS 2 SRPC 1 SRPC 2

AD Price Level 19 AS GDP R QYQY LRAS Inflation SRPC Unemployment UYUY LRPC AS 2 PL e SRPC 1 AD 2

Do you remember the wage- price-spiral? 20

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The Good, the Bad, and the Ugly UnemploymentInflationGDP Growth Good6% or less1%-4%2.5%-5% Worry6.5%-8%5%-8%1%-2% Bad8.5 % or more9% or more.5% or less 22

Review of the Phillips Curve 23