1. The Short-Run Trade-Off between Inflation and Unemployment36
The Short-Run Trade-Off between Inflation and Unemployment

2. Figure 1 The Phillips Curve
Inflation
rate
(per cent
Phillips curve
per year) 4 B 6 7 A 2
Unemployment
rate (per cent)
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3. Figure 2 How the Phillips Curve is Related to Aggregate Demand and Aggregate Supply
(a) The model of aggregate demand and aggregate supply
(b) The Phillips curve
Price
Inflation
level
Short-run
aggregate
supply
High
aggregate demand
rate
(per cent
Phillips curve
per year)
Low aggregate
demand
(output is
8,000) B 4 6
8,000
(unemployment
is 4%)
106 B
(unemployment
is 7%)
7,500
102 A
(output is
7,500) A 7 2
Quantity
Unemployment
of output
rate (per cent)
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4. Figure 3 The Long-run Phillips Curve
Inflation
rate
Long-run
Phillips curve
1. When the
central bank
the growth rate
of the money
supply, the
rate of inflation
increases . . .
increases B
High
inflation
but unemployment
remains at its natural rate
in the long run.
Low
inflation A
Natural rate of
Unemployment
unemployment
rate
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5. Figure 4 How the Phillips Curve Is Related to Aggregate Demand and Aggregate Supply
(a) The model of aggregate demand and aggregate supply
(b) The Phillips curve
Price
Long-run aggregate
Inflation
Long-run Phillips
level
rate
supply
curve
1. An increase in
the money supply
increases aggregate
demand . . .
and
increases the
inflation rate . . .
AD2 P2 B B
raises
the price
level . . . A P A
Aggregate
demand, AD
Natural rate
Quantity
Natural rate of
Unemployment
of output
of output
unemployment
rate
but leaves output and unemployment
at their natural rates.
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6. Figure 5 How Expected Inflation Shifts the Short-run Phillips Curve
but in the long run, expected
inflation rises, and the short-run
Phillips curve shifts to the right.
Inflation
rate
Long-run
Short-run Phillips curve
with high expected
inflation
Phillips curve C
Short-run Phillips curve
with low expected
inflation B
1. Expansionary policy moves
the economy up along the
short-run Phillips curve . . . A
Natural rate of
Unemployment
unemployment
rate
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7. Figure 6 The Breakdown of the Phillips Curve
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8. Figure 7 Aggregate Demand/Aggregate Supply and the Phillips Curve: Two Ways of Telling the Same Story
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9. Figure 8 An Adverse Shock to Aggregate Supply
(a) The model of aggregate demand and aggregate supply
(b) The Phillips curve
Price
Inflation
giving policymakers
a less favourable trade-off
between unemployment
and inflation.
level
AS2
rate
Aggregate
PC2 B
supply, AS
1. An adverse
shift in aggregate
supply . . . B P2 Y2
and
raises
the price
level . . . P A Y A
Aggregate
demand
Phillips curve, P C
Quantity
Unemployment
lowers output . . .
of output
rate
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10. Figure 9 The Supply Shocks of the 1970s
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11. Figure 10 The Traditional Explanation of the Effect of a Minimum Wage Set Above the Equilibrium Wage Level
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12. Figure 11 A Microeconomic Model of the Labour Market
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13. Figure 12 Disinflationary Monetary Policy in the Short Run and the Long Run
1. Contractionary policy moves
the economy down along the
short-run Phillips curve . . .
Inflation
Long-run
rate
Phillips curve
Short-run Phillips curve
with high expected
inflation A
Short-run Phillips curve
with low expected
inflation C B
but in the long run, expected
inflation falls, and the short-run
Phillips curve shifts to the left.
Natural rate of
Unemployment
unemployment
rate
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14. Figure 13 The Thatcher Disinflation
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