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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) Copyright © 2011 Cengage Learning 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) Copyright © 2011 Cengage Learning 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 Copyright © 2011 Cengage Learning 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. Copyright © 2011 Cengage Learning 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 Copyright © 2011 Cengage Learning Figure 6 The Breakdown of the Phillips Curve Copyright © 2011 Cengage Learning Figure 7 Aggregate Demand/Aggregate Supply and the Phillips Curve: Two Ways of Telling the Same Story Copyright Copyright © 2011 Cengage © 2010 Learning Cengage Learning 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 Copyright © 2011 Cengage Learning Figure 9 The Supply Shocks of the 1970s Copyright © 2011 Cengage Learning Figure 10 The Traditional Explanation of the Effect of a Minimum Wage Set Above the Equilibrium Wage Level Copyright © 2011 Cengage Learning Figure 11 A Microeconomic Model of the Labour Market Copyright © 2011 Cengage Learning 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. Copyright © 2011 Cengage Learning Figure 13 The Thatcher Disinflation Copyright © 2011 Cengage Learning