Download The Phillips Curve: Short Run and Long Run

2.4 E
(HL only)
The Phillips
Curve:
Short Run
and Long Run
Inflation and Unemployment using
AS/AD
YF
Inflation
AS1
Expansionary fiscal or monetary
policy will lead to a rise in AD,
thus more GDP, thus less u/e
3.75%
2%
U/E
AD2
AD1
Y1
Y2
Real National Income
CPI % (Inflation)
The Phillips Curve
It suggested that if governments
wanted to reduce unemployment
it had to accept higher inflation as
a trade-off.
2.5%
Money illusion – wage rates rising
but individuals not factoring in
inflation on real wage rates.
1.5%
4%
6%
PC1
Unemployment (%)
The Phillips Curve
 Problems:
 1970s
– Inflation
and unemployment rising
at the same time – stagflation
 Phillips Curve redundant?
 Or was it moving?
The LR Phillips Curve
Inflation
Long Run PC
If workers stop “suffering from the
money illusion” they will demand
for higher wages to keep their real
wages constant (at least).
An inward shift of the Phillips
Curve would result in lower
unemployment levels associated
with higher inflation.
15%
7%
2%
PC3
7%
PC1
PC2
Unemployment
The Phillips Curve
 Where
the long run Phillips Curve cuts the
horizontal axis would be the rate of
unemployment at which inflation was
constant – the so-called
Non-Accelerating Inflation Rate of
Unemployment (NAIRU) = NRU
The Phillips Curve

To reduce unemployment
to below the natural rate
would necessitate:
1.
2.
Influencing expectations – persuading
individuals that inflation was going to fall
i.e. tight money policy
Boosting the supply side of the economy
- increase capacity (pushing the PC
curve outwards)
The Phillips Curve


Supply side policies have been focused on:
Education:





Welfare benefits:



Boosting the number of those staying on at school
Boosting numbers going to university
Lifelong learning
Vocational education
The working family tax credit
Incentives to work
Labour market flexibility