1. The Phillips Curve Unemployment vs. Inflation
Managing the short run trade-off

2. Full Employment & Inflation
Full Employment rate depends on features of a labor market:
Including: minimum-wage laws, market power of unions, effectiveness of job search (think internet) , & other labor laws etc….
In USA = 4.0% In France = 8.0%
Inflation rate depends on growth in the quantity of money
Supply of money is controlled by the Federal Reserve
creates demand-pull inflation

3. Short Run Trade Off: Fiscal Policy
Expansionary => ↑ AD => unemployment falls but inflation ↑
Contractionary =>↓ AD => inflation falls but unemployment ↑
LRAS1
Price
Level
Real
GDP
SRAS1
AS/AD Model Conclusion
There is a short run trade off between:
inflation & unemployment
2) There is no long run relationship….
AD2 P2 Y2 E2
AD1 P1 E1 Y1

4. Short Run Phillips Curve (SRPC)
% Inflation
You can lower unemployment by creating ↑ inflation (in short run)
Rate
SRPC 3% B 6 4% A 2
% Unemployment
Rate

5. SRAS & SRPC 1) If AD ↑ => Move upward SRAS => move upward SRPC
2) If SRAS shifts => SRPC shifts in the opposite direction
AS/AD Model
Short Run Phillips Curve
Price
LRAS
Inflation
Level
SRAS
AD2
Rate
SRPC
AD1
(R-GDP is
8,000) B 3% 6%
8,000
(unemployment
is 3%)
106 B
7,500
102 A
(R-GDP is
7,500) A 4% 2%
Real GDP
Unemployment
(full unemployment
is 4%)
or Output
Rate

6. The Long-Run Phillips Curve
In the 1960s, Friedman & Phelps concluded that inflation & unemployment are unrelated in long run
Inflation is only related to the Quantity Of Money
Federal Reserve controls money supply
Therefore, the Long-Run Phillips curve is vertical at full employment level

7. The Long-Run Phillips Curve
Inflation
LRPC
Rate B
High
inflation
1. When the
Fed increases
Money supply
The rate of
inflation rises
but unemployment
remains at its natural rate
in the long run.
Low
inflation A
Natural rate of
Unemployment
unemployment
Rate

8. Graphing Phillips Curves
Phillips Curves are drawn on one graph
If AS/AD full potential => Phillips full employment
Point A on both graphs
Inflationary or Recessionary Gaps will follow AS/AD shifts
B = inflationary gap
AS/AD Model
Phillips Curve Model
Price
LRAS
Inflation
LRPC
Level
AD2
8,000
(unemployment
is 3%)
106 B
SRAS
Rate
SRPC
AD1
(R-GDP is
8,000) B 3% 6%
7,500
102 A
(R-GDP is
7,500) A 4% 2%
Real GDP
Unemployment
(full unemployment
is 4%)
or Output
Rate

9. Phillips Curve Summary
Short Run => inflation increases both R-GDP & employment
Long Run => inflation does not impact R-GDP or employment
Conclusion: Fiscal Policy not helpful in
the long run! (should focus on shifting PPF!)

10. Worksheet