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The Short-Run
Trade-Off between
Inflation and
Unemployment
Copyright © 2011 Cengage Learning
36
Figure 1 The Phillips Curve
Inflation
rate
(per cent
per year)
B
6
A
2
Phillips curve
0
4
7
Unemployment
rate (per cent)
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Figure 2 How the Phillips Curve is Related to
Aggregate Demand and Aggregate Supply
(a) The model of aggregate demand and aggregate supply
Price
level
102
Inflation
rate
(per cent
per year)
Short-run
aggregate
supply
6
B
106
B
A
High
aggregate demand
Low aggregate
demand
0
(b) The Phillips curve
7,500 8,000
(unemployment (unemployment
is 7%)
is 4%)
Quantity
of output
A
2
Phillips curve
0
4
(output is
8,000)
Unemployment
7
(output is rate (per cent)
7,500)
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Figure 3 The Long-run Phillips Curve
Inflation
rate
1. When the
High
central bank
inflation
increases
the growth rate
of the money
supply, the
rate of inflation
increases . . .
Low
inflation
0
Long-run
Phillips curve
B
A
Natural rate of
unemployment
2. . . . but unemployment
remains at its natural rate
in the long run.
Unemployment
rate
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Figure 4 How the Phillips Curve Is Related to
Aggregate Demand and Aggregate Supply
(a) The model of aggregate demand and aggregate supply
Price
level
P2
2. . . . raises
the price
P
level . . .
Long-run aggregate
supply
1. An increase in
the money supply
increases aggregate
B
demand . . .
(b) The Phillips curve
Inflation
rate
Long-run Phillips
curve
3. . . . and
increases the
inflation rate . . .
B
A
A
AD2
Aggregate
demand, AD
0
Natural rate
of output
Quantity
of output
0
Natural rate of
unemployment
Unemployment
rate
4. . . . but leaves output and unemployment
at their natural rates.
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Figure 5 How Expected Inflation Shifts the Shortrun Phillips Curve
Inflation
rate
2. . . . but in the long run, expected
inflation rises, and the short-run
Phillips curve shifts to the right.
Long-run
Phillips curve
C
B
Short-run Phillips curve
with high expected
inflation
A
1. Expansionary policy moves
the economy up along the
short-run Phillips curve . . .
0
Short-run Phillips curve
with low expected
inflation
Natural rate of
unemployment
Unemployment
rate
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Figure 6 The Breakdown of the Phillips Curve
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Figure 7 Aggregate Demand/Aggregate Supply and the
Phillips Curve: Two Ways of Telling the Same Story
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Figure 8 An Adverse Shock to Aggregate Supply
(a) The model of aggregate demand and aggregate supply
Price
level
AS2
P2
3. . . . and
raises
the price
level . . .
B
A
P
Aggregate
supply, AS
(b) The Phillips curve
Inflation
rate
1. An adverse
shift in aggregate
supply . . .
4. . . . giving policymakers
a less favourable trade-off
between unemployment
and inflation.
B
A
PC2
Aggregate
demand
0
Y2
Y
2. . . . lowers output . . .
Quantity
of output
Phillips curve, P C
0
Unemployment
rate
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Figure 9 The Supply Shocks of the 1970s
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Figure 10 The Traditional Explanation of the Effect of a
Minimum Wage Set Above the Equilibrium Wage Level
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Figure 11 A Microeconomic Model of the Labour Market
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Figure 12 Disinflationary Monetary Policy in the
Short Run and the Long Run
Inflation
rate
Long-run
Phillips curve
1. Contractionary policy moves
the economy down along the
short-run Phillips curve . . .
A
Short-run Phillips curve
with high expected
inflation
C
B
Short-run Phillips curve
with low expected
inflation
0
Natural rate of
unemployment
Unemployment
2. . . . but in the long run, expected rate
inflation falls, and the short-run
Phillips curve shifts to the left.
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Figure 13 The Thatcher Disinflation
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