© 2007 thomson south-western phillips curve. © 2007 thomson south-western the phillips curve...
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© 2007 Thomson South-Western
Phillips Curve
© 2007 Thomson South-Western
The Phillips Curve
Phillips Curve (PC)–
• relationship between Inflation and Unemployment
Short Run Phillips Curve
© 2007 Thomson South-Western
The Phillips Curve
Deflation + extremely high UE rates = PC below the x axis (negative)
© 2007 Thomson South-Western
The Phillips Curve
CH
UnemploymentRate (percent)
0
InflationRate
(percentper year)
Phillips curve
4
B6
7
A2
Copyright © 2004 South-Western
© 2007 Thomson South-Western
Long Run Phillips Curve (LRPC)
• LRPC is at the Natural Rate of Unemployment
© 2007 Thomson South-Western
The Long-Run Phillips Curve
UnemploymentRate
0 Natural rate ofunemployment
InflationRate Long-run
Phillips curve
BHighinflation
Lowinflation
A
2. . . . but unemploymentremains at its natural ratein the long run.
1. When the Fed increases the growth rate of the money supply, the rate of inflation increases . . .
Copyright © 2004 South-Western
© 2007 Thomson South-Western
How the Phillips Curve is Related to Aggregate Demand and Aggregate Supply
Quantityof Output
Natural rateof output
Natural rate ofunemployment
0
PriceLevel
P
Aggregatedemand, AD
Long-run aggregatesupply
Long-run Phillipscurve
(a) The Model of Aggregate Demand and Aggregate Supply
UnemploymentRate
0
InflationRate
(b) The Phillips Curve
2. . . . raisesthe pricelevel . . .
1. An increase in the money supplyincreases aggregatedemand . . .
AAD2
B
A
4. . . . but leaves output and unemploymentat their natural rates.
3. . . . andincreases theinflation rate . . .
P2B
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© 2007 Thomson South-Western
Expectations
• Expected inflation measures how much people expect the overall price level to change.
© 2007 Thomson South-Western
How Expected Inflation Shifts the Short-Run Phillips Curve
UnemploymentRate
0 Natural rate ofunemployment
InflationRate Long-run
Phillips curve
Short-run Phillips curvewith high expected
inflation
Short-run Phillips curvewith low expected
inflation
1. Expansionary policy movesthe economy up along the short-run Phillips curve . . .
2. . . . but in the long run, expectedinflation rises, and the short-run Phillips curve shifts to the right.
CB
A
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© 2007 Thomson South-Western
Supply Shocks and the PC
• A supply shock is an event that directly alters the firms’ costs, and, as a result, the prices they charge.
• This shifts the economy’s aggregate supply curve. . .
• . . . and as a result, the Phillips curve.
© 2007 Thomson South-Western
An Adverse Shock to Aggregate Supply
Quantityof Output
0
PriceLevel
Aggregatedemand
(a) The Model of Aggregate Demand and Aggregate Supply
UnemploymentRate
0
InflationRate
(b) The Phillips Curve
3. . . . andraises the price level . . .
AS2 Aggregatesupply, AS
A
1. An adverseshift in aggregate supply . . .
4. . . . giving policymakers a less favorable tradeoffbetween unemploymentand inflation.
BP2
Y2
PA
Y
Phillips curve, PC
2. . . . lowers output . . .
PC2
B
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