Short Run Phillips Curve Flashcards
(30 cards)
Who was A.W. Phillips and what did he discover?
A New Zealand economist who found an inverse relationship between wage growth and unemployment — as unemployment falls, wage growth increases.
What does the Short-Run Phillips Curve (SRPC) show?
An inverse relationship between inflation and unemployment: when unemployment is low, inflation is high, and vice versa.
Why is the SRPC downward-sloping?
In the short run, lower unemployment increases workers’ bargaining power → wages rise → costs increase → inflation rises.
Why did economists later replace “wage growth” with “inflation” on the y-axis of the Phillips Curve?
Because in the 1960s, wages were a major component of business costs, especially in labor-intensive industries — so wage growth led directly to inflation.
What policy trade-off does the SRPC suggest?
Governments may have to choose between lower unemployment (with higher inflation) and lower inflation (with higher unemployment).
What happens on the SRPC when the economy is in a recession?
High unemployment → weak bargaining power → slower wage growth → lower inflation or even deflation.
How does low unemployment lead to inflation, according to the Phillips Curve?
Firms compete for fewer available workers, increasing wages → higher costs → cost-push inflation.
In the 1960s, what assumption supported the validity of the SRPC?
That inflation expectations were stable, so the trade-off between inflation and unemployment held in the short run.
What does the SRPC not account for, which becomes important in the long run?
Expectations — workers and firms adjust their behavior if they expect inflation, altering the relationship. This leads to the Long-Run Phillips Curve (LRPC), which is vertical.
How does the SRPC help explain demand-side policy choices?
It suggests that expansionary fiscal or monetary policy can reduce unemployment but at the cost of higher inflation — useful for short-run stabilization.
What happens on the SRPC when Aggregate Demand (AD) increases?
Movement up the curve: Unemployment falls, but inflation rises due to higher demand and wage pressures.
What happens on the SRPC when Aggregate Demand (AD) decreases?
Movement down the curve: Inflation falls, but unemployment rises as demand weakens.
What is the Natural Rate of Unemployment (NRU)?
The level of unemployment where inflation is stable — also called the Non-Accelerating Inflation Rate of Unemployment (NAIRU). It’s the long-run equilibrium level of unemployment.
What does the Long-Run Phillips Curve (LRPC) look like and why?
It’s vertical at the NRU — because in the long run, there is no trade-off between inflation and unemployment once inflation expectations adjust.
What is stagflation, and why did it challenge the original Phillips Curve?
Stagflation is a period of high inflation and high unemployment — it showed that the simple SRPC was flawed, as the two could rise together (e.g., 1970s oil shocks).
How did economists adapt the Phillips Curve after stagflation?
By introducing inflation expectations into the model → creating the Expectations-Augmented Phillips Curve, where SRPC shifts outward when expected inflation rises.
What does the Expectations-Augmented Phillips Curve explain?
That if policymakers try to keep unemployment below the NRU, inflation will keep rising — causing the SRPC to shift right.
What is the inflation-unemployment trade-off in the short run vs. long run?
Short run: Trade-off exists (SRPC slopes downward)
Long run: No trade-off (LRPC is vertical at NRU)
What is the main policy implication of the Phillips Curve for inflation targeting?
Trying to push unemployment below its natural rate will only cause rising inflation in the long run, so central banks often target low, stable inflation (e.g., 2%).
Which economic schools differ on the use of demand-side policy in response to unemployment?
Keynesians: Support active demand-side policies to reduce unemployment.
Monetarists/Classical: Caution that such policies cause inflation with no long-term gain in employment.
What is stagflation?
A situation where inflation is high and unemployment is high at the same time — something the original Phillips Curve could not explain.
What causes stagflation in the AD/AS model?
A negative supply-side shock, such as a rise in oil prices or production costs → shifts SRAS left → increases price level and reduces output.
What happens to the SRPC during a negative supply shock?
The SRPC shifts right — at every level of unemployment, there is now higher inflation due to increased costs.
Why does the Phillips Curve struggle to show stagflation initially?
Because the original SRPC only showed a trade-off between inflation and unemployment — it didn’t account for supply-side shocks that move both up.
