1. Chapter 16- The Phillips Curve
9/16/2018
Chapter 16- The Phillips Curve
Objective – Students will be able to answer questions regarding the Phillips Curve.
SECTION 1
© 2001 by Prentice Hall, Inc.

2. The Phillips Curve
In a 1958 paper, New Zealand born economist, A.W. Phillips published the results of his research on the historical relationship between the unemployment rate (u%) and the rate of inflation (π%) in Great Britain. His research indicated a stable inverse relationship between the u% and the π%. As u%↓, π%↑ ; and as u%↑, π%↓.

3. The Phillips Curve (hypothetical example)π% . . . 4% . . . 2% . PC 5% 7% u%
Note: Inflation Expectations are held constant

4. Trouble for the Phillips Curve
In the 1970’s the United States experienced concurrent high u% & π%, a condition known as stagflation American Nobel Prize economist Milton Friedman saw stagflation as disproof of the stable Phillips Curve. Instead of a trade-off between u% & π%, Friedman and Nobel Prize recipient Edmund Phelps believed that the natural u% was independent of the π%. This independent relationship is now referred to as the Long- Run Phillips Curve.

5. The Long-Run Phillips Curveπ%
LRPC
un% u%
Note: Natural rate of unemployment is held constant

6. The Long-Run Phillips Curve (LRPC)
Because the Long-Run Phillips Curve exists at the natural rate of unemployment (un), structural changes in the economy that affect un will also cause the LRPC to shift.
Increases in un will shift LRPC 
Decreases in un will shift LRPC 

7. The Short-Run Phillips Curve (SRPC)
Today many economists reject the concept of a stable Phillips curve, but accept that there may be a short-term trade-off between u% & π% given stable inflation expectations. Most believe that in the long-run u% & π% are independent at the natural rate of unemployment. Modern analysis shows that the SRPC may shift left or right. The key to understanding shifts in the Phillips curve is inflationary expectations!

8. The Short-Run Phillips Curve (SRPC)π% . . . . . . . . . . 4% . . . 2% .
SRPC 5% 7% u%

9. The Short-Run Phillips Curve (SRPC)π% . . . . . . . . . . 4% . . .
SRPC1 2% .
SRPC 5% 7% u%

10. Reconciling the LRPC and SRPC
π %
uN% A π% B C 
π1 % 
SRPC (π1^ %) u% u%

11. Reconciling the LRPC and SRPC
π %
uN% A π%  B C 
π1 %
SRPC (π1^ %) u% u%

12. Relating Phillips Curve to AS/AD
Changes in the AS/AD model can also be seen in the Phillips Curves
An easy way to understand how changes in the AS/AD model affect the Phillips Curve is to think of the two sets of graphs as mirror images.

13. Increase in AD = Up/left movement along SRPCπ%
LRAS . .
SRAS
SRPC  . P1
π 1    P π
AD1 AD   Y YF
GDPR un u u%
C↑, IG↑, G↑ and/or XN↑
.: AD  .: GDPR↑ & PL↑ .: u%↓ & π%↑ .: up/left along SRPC

14. Decrease in AD = Down/right along SRPCPL
LRAS π% .
SRAS
SRPC .  . . P π    P1 π1 AD
AD1   YF Y
GDPR u un u%
C↓, IG↓, G↓ and/or XN↓
.: AD  .: GDPR↓ & PL↓ .: u%↑ & π%↓ .: down/right along SRPC

15. .: SRAS  .: GDPR↑ & PL↓ .: u%↓ & π%↓ .: SRPC  (Disinflation)
SRAS  = SRPC 
SRAS
SRPC PL π%
LRPC
LRAS . .
SRAS1
SRPC1   . . P π   P1 π1 AD   Y YF
GDPR un u u%
Inflationary Expectations↓, Input Prices↓, Productivity↑, Business Taxes↓, and/or Deregulation
.: SRAS  .: GDPR↑ & PL↓ .: u%↓ & π%↓ .: SRPC  (Disinflation)

16. .: SRAS  .: GDPR↓ & PL↑ .: u%↑ & π%↑ .: SRPC  (Stagflation)
SRAS  = SRPC 
SRAS1
SRPC1 π% PL
LRAS
LRPC
SRAS
SRPC . .   . . P1
π 1   P π AD   Y1 YF
GDPR un u1 u%
Inflationary Expectations↑, Input Prices↑, Productivity↓, Business Taxes↑, and/or Increased Regulation
.: SRAS  .: GDPR↓ & PL↑ .: u%↑ & π%↑ .: SRPC  (Stagflation)

17. Summary
There is a short-run trade off between u% & π%. This is referred to as a short-run Phillips Curve (SRPC)
In the long-run, no trade-off exists between u% & π%. This is referred to as the long-run Phillips Curve (LRPC)
The LRPC exists at the natural rate of unemployment (un).
un ↑ .: LRPC 
un ↓ .: LRPC 
ΔC, ΔIG, ΔG, and/or ΔXN = Δ AD = Δ along SRPC
AD  .: GDPR↑ & PL↑ .: u%↓ & π%↑ .: up/left along SRPC
AD  .: GDPR↓ & PL↓ .: u%↑ & π%↓ .: down/right along SRPC
Δ Inflationary Expectations, Δ Input Prices, Δ Productivity, Δ Business Taxes and/or Δ Regulation = Δ SRAS = Δ SRPC
SRAS  .: GDPR↑ & PL↓ .: u%↓ & π%↓ .: SRPC 
SRAS  .: GDPR↓ & PL ↑ .: u%↑ & π%↑.: SRPC 

18. Section 1 Assessment
1. Graph and verbally describe what would happen to the short run Phillips Curve if their was an increase in consumption in a society. What would happen to the inflation and unemployment rate? 2. Graph and verbally describe what would happen to the short run Phillips Curve if their was an increase in business taxes. What would happen to the inflation and unemployment rate?

19. Summary: In a paragraph, describe what you have learned today.