PHILLIPS CURVE Phillips Curve Short and Long Run

PHILLIPS CURVE

Phillips Curve Short and Long Run Phillips Curves • William Phillips, a New Zealand born economist, wrote a paper in 1958 titled The Relation between Unemployment and the Rate of Change of Money Wage Rates in the United Kingdom, 1861 -1957, which was published in the quarterly journal Economica. • In the paper Phillips describes how he observed an inverse relationship between money wage changes and unemployment in the British economy over the period examined

PHILLIPS CURVE SHORT AND LONG RUN PHILLIPS CURVES • In the years following Phillips' 1958 paper, many economists in the advanced industrial countries believed that his results showed that there was a permanently stable relationship between inflation and unemployment. • One implication of this for government policy was that governments could control unemployment and inflation with a Keynesian policy. • They could tolerate a reasonably high rate of inflation as this would lead to lower unemployment – there would be a trade-off between inflation and unemployment. • For example, monetary policy and/or fiscal policy (i. e. , deficit spending) could be used to stimulate the economy, raising gross domestic product and lowering the unemployment rate. Moving along the Phillips curve, this would lead to a higher inflation rate, the cost of enjoying lower unemployment rates.

When the Economy. Phillips is at Full Employment Curve (“F-E RGDP”) Aggregate Demand (AD), Short Run Aggregate Supply (SRAS)and Long Run Inflation Aggregate Supply (LRAS) all intersect at the same point “A” 1. Actual RGDP = Potential RGDP (F-E RGDP) 2. Actual Unemployment Rate = The Natural Rate of Unemployment (NRU) or the Non-Accelerating Inflation Rate of Unemployment (NAIRU) 3. We assume Price Stability at “PL*” Aggregate Demand/Aggregate Supply Price Level LRAS SRAS “A” PL* Any deviation from Point “A” is going to create a different relationship between Inflation and Unemployment. AD Fe RGDP Unemployment Quantity of Real GDP

Phillips Curve Inflation I* Aggregate Demand/Aggregate Supply Price If we take this Inflation Rate. Level and Unemployment Rate and plot it on our Phillips Curve Graph, we have Our first point on our Phillips Curve—Point “A” LRAS SRAS “A” PL* AD UR* (NRU) Unemployment Fe RGDP Quantity of Real GDP

Phillips Curve Inflation Assume AD INCREASES and shifts To the RIGHT. Aggregate Demand/Aggregate Supply Price Level LRAS SRAS The new equilibrium is Point “B” at “PL 1” and “RGDP 1”. Inflation has INCREASED (“Demand-Pull”) RGDP has INCREASED Unemployment has DECREASED “A” I* “B” PL 1 “A” PL* AD 1 AD UR 1 UR* (NRU) Unemployment Fe RGDP 1 Quantity of Real GDP

Phillips Curve Inflation Aggregate Demand/Aggregate Supply Price If we plot this new relationship Between Inflation and Unemployment, Level We are now at Point “B” on the Phillips Curve HIGHER and to the LEFT of “A” LRAS SRAS Inflation increased from “I* to I 1” and Unemployment Decreased from “UR* to UR 1” I 1 “B” “A” I* “B” PL 1 “A” PL* AD 1 AD UR 1 UR* (NRU) Unemployment Fe RGDP 1 Quantity of Real GDP

Phillips Curve Aggregate Demand/Aggregate Supply Price Level Inflation Notice the INVERSE relationship between Inflation and Unemployment that occurred as AD shifted to the RIGHT. I 1 “B” SRAS “B” PL 1 “A” I* LRAS “A” PL* AD 1 AD UR 1 UR* (NRU) Unemployment Fe RGDP 1 Quantity of Real GDP

Phillips Curve Inflation Lets keep Point “B” on the Phillips Curve and start over on the AD/AS graph and see what happens If AD DECREASES. “B” “A” I* Aggregate Demand/Aggregate Supply Price Level LRAS PL 1 “A” PL* PL 2 UR 1 UR* (NRU) Unemployment SRAS AD RGDP 2 Fe RGDP 1 Quantity of Real GDP

Phillips Curve Inflation AD DECREASES and shifts to the LEFT. Price LRAS Level New equilibrium at Point “C” with A lower level of Inflation “PL 2” and a higher level of Unemployment that Accompanies a lower level or RGDP (“RGDP 2”) “B” I* Aggregate Demand/Aggregate Supply SRAS PL 1 “A” PL* PL 2 “C” AD AD 2 UR* (NRU) Unemployment RGDP 2 Fe RGDP 1 Quantity of Real GDP

Phillips Curve Inflation Aggregate Demand/Aggregate Supply If we plot this point on our Price Phillips Curve we can establish Level Point “C”, that illustrates Inflation DECREASING from “I* to I 2” and Unemployment INCREASING from UR* To “UR 2”. It is down and to the right of “A” “B” “A” PL* “C” I 2 SRAS PL 1 “A” I* LRAS PL 2 “C” AD AD 2 UR 1 UR* UR 2 (NRU) Unemployment RGDP 2 Fe RGDP Quantity of Real GDP

Phillips Curve Inflation Aggregate Demand/Aggregate Supply Once again, note the INVERSE Price Relationship between Inflation Level And Unemployment that occurred as AD DECREASED and shifted to the LEFT “B” “A” PL* “C” I 2 SRAS PL 1 “A” I* LRAS PL 2 “C” AD AD 2 UR 1 UR* UR 2 (NRU) Unemployment RGDP 2 Fe RGDP Quantity of Real GDP

Phillips Curve Inflation Aggregate Demand/Aggregate Supply Price Level We have established 3 core points on our Phillips Curve Graph which Lets re-insert the AD shifts on the Graphs to the right. LRAS SRAS we Derived from the AD shifts- either to the left or to the right ALONG our FIXED SRAS curve. Each shift, RELATIVE to the starting point At Full-Employment, represents a change in the Relationship between Inflation and Unemployment I 1 “B” “A” I* PL* “C” I 2 “B” PL 1 PL 2 AD 1 “C” AD AD 2 UR 1 UR* UR 2 (NRU) Unemployment RGDP 2 Fe RGDP 1 Quantity of Real GDP

Phillips Curve Inflation I 1 Aggregate Demand/Aggregate Supply To finish out our Phillips. Price Curve we need to look at the 2 extremes Level and see what happens to the relationship between Inflation and Unemployment if AD 1 curve kept increasing and shifting to the RIGHT or AD 2 is kept decreasing and shifting to the LEFT “B” LRAS “B” PL 1 “A” I* PL* “C” I 2 PL 2 SRAS AD 1 “C” AD AD 2 UR 1 UR* UR 2 (NRU) Unemployment RGDP 2 Fe RGDP 1 Quantity of Real GDP

If AD 1 Curve continued to shift to the RIGHT we would produce no more RGDP, hence the Unemployment Rate would not drop any further. Aggregate Demand/Aggregate Supply Phillips Curve Pricein unemployment, but we We would have no decrease would have increasing. Level Inflation LRAS SRAS This is represented by the VERTICAL section of the Phillips Curve I 1 “B” “A” I* PL* “C” I 2 “B” PL 1 PL 2 AD 1 “C” AD AD 2 UR 1 UR* UR 2 (NRU) Unemployment RGDP 2 Fe RGDP 1 Quantity of Real GDP

If AD 2 Curve continued to shift to the LEFT we would continue to have a decrease in RGDP and an increase in Unemployment BUT the Inflation would eventually level Aggregate Demand/Aggregate Supply out because “stuff “would never be produced below Price certain prices. Phillips Curve Inflation Level We would have a continued decrease in unemployment, but we would have a bottoming out of Inflation LRAS SRAS This is represented by the HORIZONTAL section of the Phillips Curve “B” PL 1 “A” PL* “C” PL 2 “C” AD SRPC* UR 1 UR* UR 2 (NRU) Unemployment AD 1 AD 2 RGDP 2 Fe RGDP 1 Quantity of Real GDP

Phillips Curve Aggregate Demand/Aggregate Supply Price Level Inflation LRAS Connect the dots and we have a “SHORT RUN PHILLIPS CURVE” “Short Run “B” Phillips Curve” “B” PL 1 “A” PL* “C” PL 2 UR* UR 2 (NRU) Unemployment AD 1 “C” AD SRPC* UR 1 SRAS AD 2 RGDP 2 Fe RGDP 1 Quantity of Real GDP

Short Run Phillips Curve Represents the trade-off between Inflation and Unemployment as AD increases or decreases ALONG the Fixed Short Run Aggregate Supply Curve

What SHIFTS the Short Run Phillips Curve (SRPC) to the Left or to the Right? Short Run Aggregate Supply Shocks! A NEGATIVE SUPPLY shock (SRAS shifts to the LEFT) LEFT will shift the SRPC to the RIGHT! A POSITIVE SUPPLY shock (SRAS shifts to the RIGHT) RIGHT will shift the SRPC to the LEFT

Phillips Curve Aggregate Demand/Aggregate Supply Price Level Inflation LRAS SRAS Let start over to illustrate how a Shift in the SRAS curve will cause a Shift of the Phillips Curve. “B” For simplicity I will take out the LRAS, but Understand it still exits. “A” PL* “C” AD SRPC* UR 1 UR* UR 2 (NRU) Unemployment Fe RGDP Quantity of Real GDP

Phillips Curve Aggregate Demand/Aggregate Supply Price Level Inflation SRAS “B” “A” PL* “C” AD SRPC* UR 1 UR* UR 2 (NRU) Unemployment Fe RGDP Quantity of Real GDP

Phillips Curve Aggregate Demand/Aggregate Supply Assume a Negative Supply Shock Price SRAS curve shifts to the LEFT and we establish a new equilibrium a Level At Point “B”—”COST PUSH INFLATION” Inflation SRAS 1 SRAS Price Level INCREASES RGDP DECREASES Unemployment INCREASES “B” Opps!---this does not conform to our nice and neat INVERSE relationship between Inflation and Unemployment. It appears now to be a DIRECT relationship PL 1 “B” “A” PL* “C” AD SRPC* UR 1 UR* UR 2 (NRU) Unemployment RGDP 1 Fe RGDP Quantity of Real GDP

Phillips Curve Inflation Aggregate Demand/Aggregate Supply Notice Point “B” on AD/AS is at a HIGHER Price Level of Inflation AND a HIGHER Level level Of Unemployment RELATIVE to Point “A”. If we plot this point on the Phillips Curve Graph We will find that point is ABOVE and to the LEFT of “A” “B” PL 1 SRAS “B” “A” PL* “C” AD SRPC* UR 1 UR* UR 2 (NRU) Unemployment RGDP 1 Fe RGDP Quantity of Real GDP

Phillips Curve Aggregate Demand/Aggregate Supply Price Level Inflation SRAS 1 We have established ONE Inflation/Unemployment Point that now lies to the RIGHT of the SRPC*. “B” PL 1 SRAS “B” “A” PL* “C” AD SRPC* UR 1 UR* UR 2 (NRU) Unemployment RGDP 1 Fe RGDP Quantity of Real GDP

Phillips Curve Inflation Aggregate Demand/Aggregate Supply Price If policies were implemented to shift AD either to the Levela NEW Phillips Curve that LEFT or RIGHT we would create lies to the RIGHT of the previous one (SRPC*) “B” PL 1 SRAS “B” “A” PL* “C” AD SRPC* UR 1 UR* UR 2 (NRU) Unemployment RGDP 1 Fe RGDP Quantity of Real GDP

Phillips Curve Aggregate Demand/Aggregate Supply Price Level Inflation SRAS 1 SRAS Helpful Hint: If SRAS curve shifts to the LEFT Then the Phillips Curve will shift to the RIGHT “B” PL 1 “B” “A” PL* “C” SRPC 1 AD SRPC* UR 1 UR* UR 2 (NRU) Unemployment RGDP 1 Fe RGDP Quantity of Real GDP

Phillips Curve Aggregate Demand/Aggregate Supply Price Level Inflation SRAS 1 SRAS How it looks cleaned up!! PL* SRPC 1 AD SRPC* UR 1 UR* UR 2 (NRU) Unemployment RGDP 1 Fe RGDP Quantity of Real GDP

Phillips Curve Aggregate Demand/Aggregate Supply Price Level Inflation “B” SRAS What happens to the Phillips Curve If there is a POSTIVE Supply Shock? “A” PL* “C” AD SRPC* UR 1 UR* UR 2 (NRU) Unemployment Fe RGDP Quantity of Real GDP

Phillips Curve Aggregate Demand/Aggregate Supply Assume a Positive Supply Shock Price SRAS curve shifts to the RIGHT and we establish a new equilibrium a Level At Point “B” Inflation SRAS 1 Price Level DECREASES RGDP INCREASES Unemployment DECREASES “B” Opps!---this does not conform to our nice and neat INVERSE relationship between Inflation and Unemployment. It appears now to be a DIRECT relationship “A” PL* “C” “B” PL 1 AD SRPC* UR 1 UR* UR 2 (NRU) Unemployment Fe RGDP 1 RGDP Quantity of Real GDP

Phillips Curve Inflation Aggregate Demand/Aggregate Supply Notice Point “B” on AD/AS is at a LOWER Price Level of Inflation AND a LOWER Level level of Unemployment RELATIVE to Point “A”. If we plot this point on the Phillips Curve Graph we will find that point is BELOW and to the LEFT of “A” SRAS 1 “B” “A” “B” PL* “C” “B” PL 1 AD SRPC* UR 1 UR* UR 2 (NRU) Unemployment Fe RGDP 1 RGDP Quantity of Real GDP

Phillips Curve Aggregate Demand/Aggregate Supply Price Level Inflation We have established ONE Inflation/Unemployment Point that now lies to the LEFT of the SRPC*. SRAS 1 “B” “A” “B” PL* “C” “B” PL 1 AD SRPC* UR 1 UR* UR 2 (NRU) Unemployment Fe RGDP 1 RGDP Quantity of Real GDP

Phillips Curve Inflation Aggregate Demand/Aggregate Supply Price If policies were implemented to shift AD either to the Levela NEW Phillips Curve that LEFT or RIGHT we would create lies to the LEFT of the previous one (SRPC*) SRAS 1 “B” “A” “B” PL* “C” “B” PL 1 AD SRPC* SRPC 1 UR* UR 2 (NRU) Unemployment Fe RGDP 1 RGDP Quantity of Real GDP

Phillips Curve Aggregate Demand/Aggregate Supply Price Level Inflation SRAS 1 Helpful Hint: If SRAS curve shifts to the RIGHT Then the Phillips Curve will shift to the LEFT “B” “A” “B” PL* “C” “B” PL 1 AD SRPC* SRPC 1 UR* UR 2 (NRU) Unemployment Fe RGDP 1 RGDP Quantity of Real GDP

Phillips Curve Aggregate Demand/Aggregate Supply Price Level Inflation SRAS 1 Here is how it looks cleaned up! AD SRPC* SRPC 1 UR* UR 2 (NRU) Unemployment Fe RGDP 1 RGDP Quantity of Real GDP

Long Run Phillips Curve Easy, Cheesey!! In the long run, there is no trade off between Inflation and Unemployment

Phillips Curve Aggregate Demand/Aggregate Supply Price Level Inflation LRAS SRAS We will start out at our neutral position. The NRU and Price Stability---the “NAIRU” I* “A” PL* AD* UR* (NRU) Unemployment Fe RGDP Quantity of Real GDP

Phillips Curve Inflation Assume AD increases and shifts to the RIGHT. Aggregate Demand/Aggregate Supply Price Level LRAS SRAS Price Level INCREASES RGDP INCREASES Unemployment DECREASES Our new equilibrium is at Point “B” (note this!) Absent any policy interventions we will see how the “Self-Correcting Mechanism” will work to “A” get the economy back to full-employment I* PL 1 “B” “A” PL* AD 1 AD* UR* (NRU) Unemployment Fe RGDP 1 Quantity of Real GDP

Phillips Curve Aggregate Demand/Aggregate Supply Price Level Inflation LRAS SRAS We already know that this movement along the SRAS Curve IN THE SHORT RUN and will create movement ALONG a Short Run Phillips Curve (Up and to the Left). However, now we want to transition to the LONG RUN situation. PL 1 I* “A” “B” “A” PL* AD 1 AD* UR* (NRU) Unemployment Fe RGDP 1 Quantity of Real GDP

Phillips Curve Inflation Aggregate Demand/Aggregate Supply The economy is experiencing INFLATION Price AND the Actual Unemployment Rate is now Level BELOW the NRU. LRAS SRAS This going to create conditions for “Wage Inflation” Remember: Wages are an input into the Cost of Producing When input prices INCREASE what happens to SRAS? PL 1 I* “A” “B” “A” PL* AD 1 AD* UR* (NRU) Unemployment Fe RGDP 1 Quantity of Real GDP

Phillips Curve A NEGATIVE SUPPLY SHOCK. SRAS shifts to the LEFT Inflation Aggregate Demand/Aggregate Supply Price Level INCREASES RGDP DECREASES Unemployment DECREASES LRAS SRAS 1 SRAS “C” New Equilibrium after the LONG TERM ADJUSTMENT is at Point “C” NOTE: We have returned to Full-employment RGDP and the NRU BUT at a HIGHER Price Level “A” than before I* PL 2 PL 1 “B” “A” PL* AD 1 AD* UR* (NRU) Unemployment Fe RGDP 1 Quantity of Real GDP

Phillips Curve Aggregate Demand/Aggregate Supply Price Level Inflation “C” I 1 Plot Point “C” from AD/AS on the Phillips Curve SRAS “C” PL 2 PL 1 I* LRAS SRAS 1 “A” “B” “A” PL* AD 1 AD* UR* (NRU) Unemployment Fe RGDP 1 Quantity of Real GDP

Phillips Curve Inflation Point “C” represents below Represents a HIGHER Price Level back at the NRU Aggregate Demand/Aggregate Supply Price Level “C” I 1 SRAS “C” PL 2 PL 1 I* LRAS SRAS 1 “A” “B” “A” PL* AD 1 AD* UR* (NRU) Unemployment Fe RGDP 1 Quantity of Real GDP

Now, Let’s look at it from the perspective of a DECREASE in AD

Phillips Curve Aggregate Demand/Aggregate Supply Price Level Inflation LRAS SRAS We will start out at our neutral position. “C” I 1 I* The NRU and Price Stability---the “NAIRU” “A” PL* AD* UR* (NRU) Unemployment Fe RGDP Quantity of Real GDP

Phillips Curve Inflation Assume AD decreases and shifts to the LEFT. Aggregate Demand/Aggregate Supply Price Level LRAS SRAS Price Level DECREASES RGDP DECCREASES Unemployment INCREASES “C” Our new equilibrium is at Point “B” (note this!) Absent any policy interventions we will see how the “Self-Correcting Mechanism” will work to get the economy back to full-employment I* “A” PL* PL 1 “B” AD* AD 1 UR* (NRU) Unemployment RGDP 1 Fe RGDP Quantity of Real GDP

Phillips Curve Inflation Aggregate Demand/Aggregate Supply Price The economy is experiencing RECESSION AND the Actual Unemployment Rate. Level is now ABOVE the NRU. LRAS SRAS This going to create conditions for “Wage Deflation” “C” Remember: Wages are an input into the Cost of Producing When input prices DECREASE what happens to SRAS? I* “A” PL* PL 1 “B” AD* AD 1 UR* (NRU) Unemployment RGDP 1 Fe RGDP Quantity of Real GDP

Phillips Curve Inflation A POSITIVE SUPPLY SHOCK. SRAS shifts to the RIGHT Aggregate Demand/Aggregate Supply Price Level LRAS SRAS Price Level DECREASES RGDP INCREASES Unemployment DECREASES “C” I 1 I* SRAS 1 New Equilibrium after the LONG TERM ADJUSTMENT is at Point “C” NOTE: We have returned to Full-employment RGDP and the NRU “A” BUT at a LOWER Price Level than before “A” PL* PL 1 “B” PL 2 UR* (NRU) Unemployment “C” AD* AD 1 RGDP 1 Fe RGDP Quantity of Real GDP

Phillips Curve Aggregate Demand/Aggregate Supply Price Level Inflation LRAS SRAS 1 Plot Point “C” from AD/AS on the Phillips Curve I* I 2 “A” “C” UR* (NRU) Unemployment “A” PL* PL 1 “B” PL 2 “C” AD* AD 1 RGDP 1 Fe RGDP Quantity of Real GDP

Phillips Curve Inflation Aggregate Demand/Aggregate Supply Price Level LRAS* LRAS SRAS If we connect our points on the PHILLIP CURVE We will derive the LONG RUN PHILLIPS CURVE I* “A” PL* “A” AD* UR* (NRU) Unemployment Fe RGDP Quantity of Real GDP

Phillips Curve Inflation LRAS* Aggregate Demand/Aggregate Supply Price Level LRAS SRAS The Long Run Phillips Curve suggests There is ON Long Term Trade-off between Inflation and Unemployment I* “A” PL* “A” AD* UR* (NRU) Unemployment Fe RGDP Quantity of Real GDP

What can shift the LONG RUN PHILLIPS CURVE? Anything that might change the Natural Rate of Unemployment Remember: The NRU is comprised of a. Frictional Unemployment b. Structural Unemployment Policies that INCREASE these types of unemployment will INCREASE the NRU and the LONG RUN PHILLIPS CURVE will shift to the RIGHT. Policies that DECREASE these types of unemployment will DECREASE the NRU and the LONG RUN PHILLIPS CURVE will shift to the LEFT 1. A change is government benefits for the unemployed—incentives or dis-incentives to work 2. A change in education/skill level of the population 3. An increase in Labor and Capital (Technology) Productivity

Phillips Curve and The short and long terms effects of inflaton. • We will use as an example a sub-topic from the #1 FRQ from the 2009 AP Macroeconomics Test

LRPC INFLATION LRAS Price Level SRAS PL* AD* 6% RGDP* RGDP SRPC NRU UNEMPLOYMENT The INFLATION RATE currently is 6% and the Federal Reserve believes that is too HIGH. They decide to target 3% as a “preferred” level of Inflation.

LRPC INFLATION Price Level SRAS PL* AD* 6% RGDP* RGDP SRPC NRU UNEMPLOYMENT In order to DECREASE INFLATION the Federal Reserve would carry out the Open Market Operation or SELLING BONDS---this will DECREASE the Money Supply and INCREASE the FEDERAL FUNDS RATE and tend to INCREASE INTEREST RATES throughout the Financial System.

LRPC INFLATION Price Level SRAS PL* PL 1 AD* AD 1 6% RGDP 1 RGDP* RGDP SRPC NRU UNEMPLOYMENT INCREASING INTEREST RATES will cause AD to DECREASE

LRPC INFLATION Price Level SRAS PL* PL 1 AD* AD 1 6% RGDP 1 RGDP* RGDP SRPC NRU UNEMPLOYMENT REAL GDP will DECREASE AND PRICE LEVEL (inflation) will DECREASE AND Because RGDP DECREASES, UNEMPLOYMENT will INCREASE

Price Level LRPC INFLATION SRAS PL* PL 1 AD* AD 1 6% RGDP 1 RGDP* RGDP 3% SRPC NRU UR 1 UNEMPLOYMENT INFLATION is DECREASING and UMEPLOYMENT IS INCREASING---There is MOVEMENT ALONG THE PHILLIPS CURVE IN THE SHORT RUN

Price Level LRPC INFLATION SRAS PL* PL 1 AD* AD 1 6% RGDP 1 RGDP* RGDP 3% SRPC NRU UR 1 UNEMPLOYMENT The Economy settles at a LOWER INFLATION RATE and a HIGHER UNEMPLOYMENT RATE…

Price Level LRPC INFLATION SRAS PL* PL 1 AD* AD 1 6% RGDP 1 RGDP* RGDP 3% SRPC NRU UR 1 UNEMPLOYMENT NOTE: This is the situation in the “SHORT-RUN”---What is the LONG-TERM EFFECT of the Federal Reserves action?

Price Level LRPC INFLATION SRAS PL* PL 1 AD* AD 1 6% RGDP 1 RGDP* RGDP 3% SRPC NRU UR 1 UNEMPLOYMENT People (and business and govt) EXPECTIONS about INFLATION are now going to Be “built-in”---They have expectations of LOWER PRICES AND WAGES….

Price Level LRPC INFLATION SRAS PL* PL 1 AD* AD 1 6% RGDP 1 RGDP* RGDP 3% SRPC NRU UR 1 UNEMPLOYMENT This will affect a number of things BUT lets focus on WAGES

Price Level LRPC INFLATION SRAS PL* PL 1 AD* AD 1 6% RGDP 1 RGDP* RGDP 3% SRPC NRU UR 1 UNEMPLOYMENT Because there are expectations of LOWER Inflation then WAGES tend to Stabilize and MAY decrease (assume this to be the case)…On the AD/AS Graph, which curve is going to be affected? ? ?

SRAS Price Level LRPC INFLATION SRAS 1 PL* PL 1 PL 2 6% AD* AD 1 RGDP* RGDP 2 RGDP 3% SRPC NRU UR 1 UNEMPLOYMENT Aggregate Supply!! Cost of Production will tend to DECREASE…When C. O. P DECREASES then Aggregate Supply will INCREASE (Shift to the Right)

SRAS Price Level LRPC INFLATION SRAS 1 PL* PL 1 PL 2 6% AD* AD 1 RGDP* RGDP 2 RGDP 3% SRPC NRU UR 1 UNEMPLOYMENT Price Level (inflation) has DECREASED and RGDP has INCREASED (back to the original FE FGDP* therefore UNEMPLOYMENT has DECREASED.

SRAS Price Level LRPC INFLATION SRAS 1 PL* PL 1 PL 2 6% AD* AD 1 RGDP* RGDP 2 RGDP 3% SRPC NRU UR 1 UNEMPLOYMENT How does this affect the Phillips Curve? ? ? When the SRAS curve shifts to the RIGHT The Short-Run Phillips Curve shifts to the LEFT!! Now at every level of UNEMPLOYMENT the PRICE LEVEL will be LOWER.

SRAS Price Level LRPC INFLATION SRAS 1 PL* PL 1 PL 2 6% AD* AD 1 RGDP* RGDP 2 RGDP 3% Economy is BACK to FE where AD = SRAS=LRAS We are STILL at the NRU but at a LOWER I INFLATION RATE!! SRPC NRU UR 1 UNEMPLOYMENT With the shift of The Short Run Phillips Curve we move back to Long-Run Equilibrium where SRPC intersect LRPC at the NRU…. THE LONG RUN PHILLIPS CURVE IS NOT GOING TO SHIFT.

The End