Intro to the Phillips Curve
AP Macroeconomics
http://www.glennbeck.com/content/blog/stu/marriage-equality-for-al/
Where did we come from?
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The last lesson continued to
examine the interaction
between monetary & fiscal
policy, and the impact of
monetary policy on the
following:
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Price level
Output
Unemployment
Interest rates
Investment
http://www.ronedmondson.com/2009/05/his-footprints-in-the-sand.html
Where are we going?
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In this lesson, we’ll take a look at the
relationship between inflation and
unemployment, and introduce something
called the Phillips Curve.
Phillips what?
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The Phillips Curve is an empirical
relationship founded by A.W. Phillips that
shows the relationship between the
unemployment rate and the rate at which
wages change.
He discovered that changes in wages were
inversely related to the unemployment rate.
Research since established the same
relationship between inflation and
unemployment.
“…at any given point in
time, there is a trade-off
between unemployment
and inflation.”
(Krugman, 335)
http://www.businessinsider.com/depressing-unemployment-statistics-2010-12?op=1
Short-Run
Phillips
Curve
AD and SRAS and
Short Run Phillips
Curve
Point A is the
expected
inflation rate –
natural
unemployment
rate point
If there is an unanticipated increase in AD,
unemployment decreases and inflation increases: a
movement to Point A2 (and vice versa).
Unit 5: Macroeconomics Visual 5.4
Remind me…
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Frictional unemployment is the time that
you spend looking for a job or between jobs.
Structural unemployment occurs when
there is a mismatch between skills demanded
in the labor market and the actual skills
people seeking jobs possess.
“Natural unemployment is the lowest level
of unemployment at which inflation remains
stable.”
(http://www.investopedia.com/terms/n/naturalunemployment.asp#axzz2ECmDINrF)
FYI
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Expectations about inflation increase or
decrease actual inflation.
That is, if people expect an increase in
inflation, they will demand higher wages.
Higher wages increase the actual price level,
thus increasing inflation.
“Workers and employers build the
expectation into wages and prices.”
(Krugman, 334)
AD and SRAS and Short Run Phillips Curve
We can also explain this using our AD/AS
model. Let’s say that AD & AS intersect at
full employment. Let’s say we are below the
natural level of unemployment/inflation.
Suppose that AD is expected to increase.
•AD shifts to AD1.
•The wage rate rises because of the
anticipated increase in prices: people want
to maintain their real wage.
•Increase in nominal wage shifts SRAS to
SRAS1 (we know this is a determinant for
AS).
•Thus, we are at Point A in both the Phillips
Curve graph and AD & AS graph! (it brings
us back to natural level of
inflation/unemployment)
Unit 5: Macroeconomics Visual 5.4
AD and SRAS and Short Run Phillips Curve
Now let’s say that AD shifts
again. People thought it would
move to AD1 but instead it
moves to AD2. In both graphs, it
moves to Point A2. At this point,
inflation is above the expected
rate of inflation, and
unemployment is below the
natural rate (or employment is
above the natural rate).
Unit 5: Macroeconomics Visual 5.4
What does this mean?
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If policy makers attempt to
keep the unemployment
rate at the level associated
with A2, people will come to
expect the inflation rate
associated with A2.
As a result, the SRPC will
shift upward and/or outward
until the inflation rate
associated with A2 is at the
natural rate of
unemployment (that is, the
unemployment rate will
increase until the inflation
rate at A2 in a sense
becomes Point A).
Unit 5: Macroeconomics Visual 5.4
Summary, please?
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To be continued…
If you’re really that curious…
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The short-run Phillips curve was drawn given an
expected rate of inflation and a specific natural
unemployment rate.
The SPRC will shift rightward if the expected
inflation rate increases (this occurred in the
1970s).
The SPRC will shift leftward if the natural rate of
unemployment decreases.
And now…
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Some resources:
Reffonomics:
http://www.reffonomics.com/
Morton workbook: Krugman Module 34 pp. 331335
Works Cited
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Economics of Seinfeld.
http://yadayadayadaecon.com/
Krugman, Paul, and Robin Wells. Krugman’s
Economics for AP. New York: Worth
Publishers.
Morton, John S. and Rae Jean B. Goodman.
Advanced Placement Economics: Teacher
Resource Manual. 3rd ed. New York: National
Council on Economic Education, 2003. Print.
Reffonomics. www.reffonomics.com.