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Unit 3: Aggregate Demand and Supply and Fiscal Policy 1.

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Presentation on theme: "Unit 3: Aggregate Demand and Supply and Fiscal Policy 1."— Presentation transcript:

1 Unit 3: Aggregate Demand and Supply and Fiscal Policy 1

2 The Phillips Curve Shows tradeoff between inflation and unemployment. What happens to inflation and unemployment when AD increase?

3 3 In general, there is an inverse relationship between unemployment and inflation

4 Inflation 4 SRPC Short Run Phillips Curve Unemployment 2%9% 1% 5% When the economy is overheating, there is low unemployment but high inflation When there is a recession, unemployment is high but inflation is low

5 Inflation 5 SRPC Short Run Phillips Curve Unemployment 2%9% 1% 5% What happens when AS falls causing stagflation? Increase in unemployment and inflation SRPC 1

6 Inflation 6 SRPC Short Run vs. Long Run Unemployment 2%9% 1% 5% What happens when AD increases? SRPC 1 3% 5% Long Run Phillips Curve In the long run, wages and resource prices increase. AS falls. SRPC shifts right. What happens in the long run?

7 Inflation 7 Short Run vs. Long Run Unemployment 2%9% 1% 5% 3% 5% Long Run Phillips Curve In the long run there is no tradeoff between inflation and unemployment The LRPC is vertical at the Natural Rate of Unemployment

8 Inflation 8 SRPC Short Run vs. Long Run Unemployment 2%9% 1% 5% What happens when AD falls? SRPC 1 3% 5% Long Run Phillips Curve In the long run wages fall and there is no tradeoff between inflation and unemployment What happens in the long run?

9 AD/AS and the Phillips Curve

10 Price Level 10 AD AS AD/AS and the Phillips Curve GDP R QYQY PL e LRAS Inflation SRPC Unemployment UYUY LRPC Show what happens on both graphs if AD increase AD 1

11 Price Level 11 AD AS AD/AS and the Phillips Curve GDP R QYQY PL e LRAS Inflation SRPC Unemployment UYUY LRPC Correctly draw the LRPC and SRPC with the recessionary gap. What happens when AD falls? AD 1

12 Price Level 12 AD AS AD/AS and the Phillips Curve GDP R QYQY PL e LRAS Inflation SRPC Unemployment UYUY LRPC Correctly draw the LRPC and SRPC at full employment. What happens when AS falls? AS 1 SRPC 1

13 Price Level 13 AD AS AD/AS and the Phillips Curve GDP R QYQY PL e LRAS Inflation SRPC Unemployment UYUY LRPC Correctly draw the LRPC and SRPC with an recessionary gap. What happens when AS goes up? AS 1 SRPC 1

14 The Good, the Bad, and the Ugly UnemploymentInflationGDP Growth Good6% or less1%-4%2.5%-5% Worry6.5%-8%5%-8%1%-2% Bad8.5 % or more9% or more.5% or less 14


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