Transcript (a) Using a correctly labeled graph of the short-run

Mod 34
The UnemploymentInflation
Relationship—
the Phillips Curve
Copyright © 2004 South-Western
Remember the output gaps:
Negative Gap
Remember that when the
Economy is operating BELOW
LRAS, there is an output gap.
It is a negative gap—called a
Recessionary Gap—the
difference between what AD is
and where it could be at full
potential. This means there is
higher unemployment and
lower price levels.
Copyright © 2004 South-Western
Remember the output gaps:
Positive Gap
Remember that when the
Economy is operating ABOVE
LRAS, there is an output gap.
It is a positive gap—called an
Inflationary Gap—the
difference between what AD is
and where it could be at full
potential. This means there is
lower unemployment and
higher price levels.
Copyright © 2004 South-Western
The Short-Run Phillips Curve
The Short-Run Phillips Curve
shows the trade-off between
Inflation and Unemployment
that is evident on the AD/AS
graph. It is as if we are looking
“underneath” the AD/AS graph
to see this aspect of things.
Read the graph—The higher
the inflation rate, the lower the
unemployment rate. The
higher the unemployment rate,
the lower the inflation rate.
Copyright © 2004 South-Western
Phillips Curves in the Long Run
• In the long run, the economy will settle at the natural rate of
unemployment, the unemployment rate where there is no cyclical
unemployment. Therefore, in the long run there is no relationship
between inflation and unemployment.
Inflation
Rate
LRP
C
Natura
l Rate
Unemployment
Rate
Copyright © 2004 South-Western
Short-hand for Phillips Curve
Changes and Shifts
When AD shifts, you move along the Phil Curve
AD increase—move up and left
AD decrease—move down and right
When SRAS shifts, Phil Curve shifts
SRAS increase—shift to left
SRAS decrease—shift to right
Copyright © 2004 South-Western
Phillips Curve Shifts
P
L
SRAS
2
RGDP
Inflation
Rate
SRPC
1
SRPC
2Unemployment
Rate
PL is lower at every output level
Inflation is lower at each unemployment rate
RGDP and employment are higher at each PL
Unemployment is lower at each inflation rate
Unemployment is lower at each PL
Copyright © 2004 South-Western
Phillips Curve Shifts
SRAS would shift to the left:
SRPC would shift to the right:
SRAS 2
P
L
SRAS 1
Inflation
Rate
SRPC 2
SRPC 1
RGD
PL is higher at every outputP
level
RGDP and employment are lower at each PL
Unemployment
Rate
Inflation is higher at each unemployment rate
Unemployment is higher at each inflation rate
Unemployment is higher at each PL
Copyright © 2004 South-Western
Let’s see what you have learned!
Multiple Choice Question
According to the short-run Phillips Curve, a
decrease in unemployment is expected to be
accompanied by
(A) higher labor- force participation rate
(B) an increase in inflation
(C ) an increase in the productivity of capital
(D) an increase in the government deficit
(E) a decrease in real gross domestic product
Answer is B
Copyright © 2004 South-Western
Multiple Choice Question
According to the-long run Phillips curve, which
of the following is true?
(A) Unemployment increases with an increase in inflation.
(B) Unemployment decreases with an increase in inflation
(C ) Increased automation will lead to lower levels of structural
unemployment in the long run.
(D) Changes in the composition of the overall demand for labor
tend to be deflationary in the long run.
(E) The natural rate of unemployment is independent of
monetary and fiscal policy changes that affect aggregate demand.
Answer is E
Copyright © 2004 South-Western
FRQ
3. Inflation and expected inflation are important
determinants of economic activity.
(a) Draw a correctly labeled graph of a short-run
Phillips curve.
(b) Using your graph in part (a), show the effect of an
increase in the expected rate of inflation.
(c) What is the effect of the increase in the expected rate
of inflation on the long-run Phillips curve?
Copyright © 2004 South-Western
FRQ ANSWER
a) 1 point:
• One point is earned for drawing a correctly labeled graph of
the short-run Phillips curve.
(b) 1 point:
• One point is earned for shifting the short-run Phillips curve to
the right.
(c) 1 point:
• One point is earned for stating that the increase in expected
inflation does not affect the long-run Phillips curve.
Copyright © 2004 South-Western
FRQ
1. Assume that the United States economy is in longrun equilibrium with an expected inflation rate of 6
percent and an unemployment rate of 5 percent. The
nominal interest rate is 8 percent.
(a) Using a correctly labeled graph with both the short-run and
long-run Phillips curves and the relevant numbers from
above, show the current long-run equilibrium as point A.
(b) Assume that the Federal Reserve action (targeting a 3%
inflation rate) is successful. What will happen to each of the
following as the economy approaches a new long-run
equilibrium?
(i) The short-run Phillips curve. Explain.
(ii) The natural rate of unemployment.
Copyright © 2004 South-Western
FRQ ANSWER
Copyright © 2004 South-Western
FRQ ANSWER
(b) 3 points:
•One point is earned for stating that the short-run Phillips curve
will shift to the left.
• One point is earned for explaining that Federal Reserve policy
will lower inflationary expectations.
• One point is earned for stating that the natural rate of
unemployment will remain unchanged.
Copyright © 2004 South-Western
FRQ
1. Assume the United States economy is operating at
full-employment output and the government has a
balanced budget. A drop in consumer confidence
reduces consumption spending, causing the economy to
enter into a recession.
(a) Using a correctly labeled graph of the short-run
Phillips curve, show the effect of the decrease in
consumption spending. Label the initial position “A”
and the new position “B”.
Copyright © 2004 South-Western
FRQ ANSWER
Copyright © 2004 South-Western