Phillips Curve

- relationship between unemployment and inflation
- tradeoff only occurs in the short run ( time too short to adjust to price level )

• Long Run PC ( Phillips Curve )
• occurs at natural rate of unemployment
• represented by a vertical line
• no trade off between unemployment and inflation
• only shifts if LRAS curve shift
• major assumptions is that more worker benefits creates more natural rate and lower worker benefits creates natural rate

3 Types of Natural Unemployment ( FE)

1. Structural, need update
2. Frictional, in between jobs
3. Cyclical, only available at certain seasons

-Cyclical NOT because the economy fluctuates, not natural

Short Run PC

• relevance to Okun's Law
• inverse relationship between unemployment and inflation rate
• inflation ↓ unemployment ↑
• inflation ↑ unemployment ↓
• high inflation = low unemployment
• low inflation = high unemployment
• aggregate supply shocks can cause both rate of inflation and unemployment to increase

Supply Shocks

• rapid and significant increase in resource cost, which will cause SRPC to shift
• wages are stick, inflation changes, moves points on SRPC
• if inflation persists and expected rate of inflation rises, then entire SRPC moves upward, which creates a situation called stagflation
• if inflation expectations drops due to new technology, then SRPC will move downward

Stagflation, high unemployment AND high inflation simultaneously

• BIG PROBLEM

Misery Index

• combination of inflation and unemployment in a given year
• single digit misery is good

Inflation = 2 - 3 %

Unemployment = 4 - 5 %

- these are good percentages

Long Run Phillips Curve ( LRPC )

• because LRPC exists at the natural rate of unemployment, structural changes in the economy that affect unemployment, will also cause LRPC to shjift
• increase in natural unemployment, shift →
• decrease in natural unemployment, shift ←

Phillips Curve relating to AD / AS

• changes in AD / AS can also be seen in Phillips Curve
• easy way to understand how changes in AD / AS affect Phillips Curve is to think of the two sets of graphs as mirror images
• 2 models are not equivalent, AD / AS model is static, but Phillips Curve includes changes over time whereas AD / AS shows one time changes in price level as inflation / deflation
• Phillips Curve illustrates continuous change in price level as either increase inflation / deflation

Increase AD = up / left movement SRPC

Stagflation - situation where you have high inflation and high unemployment at the same time

Disinflation - reducing in inflation value from year to year, which is usually displayed in LRPC

- decrease in inflation rate

- occurs when AD declines

- in SRPC, profits fall and unemployment rate increases

Deflation - actual drop in the price level

SRPC meet with LRPC at NRU ( natural rate of unemployment )

• graph relates inflation with unemployment = Phillips Curve
• disinflation = inflation decrease ( ex : 8 , 4 , 2 )
• cost - push inflation
• high inflation with high unemployment = stagflation
• economists call the knowledge and skills that make the workers productive = Human Capital