1. AP Macroeconomics
The Phillips Curve

2. Homework Please read your notes and pages 724-728 in your textbook.
Please answer question 4 on page 735
Graph the effects of each scenario on a properly labeled graph of AS/AD AND a graph of the Phillips Curve.

3. The Phillips Curve (hypothetical example)π% . 4% . 2% PC 5% 7% u%
Note: Inflation Expectations are held constant

4. Increase in AD = Up/left movement along SRPCπ%
LRAS . .
SRAS
SRPC  . . P1
π 1    P π
AD1 AD   Y YF
GDPR un u u%
C↑, IG↑, G↑ and/or XN↑
.: AD  .: GDPR↑ & PL↑ .: u%↓ & π%↑ .: up/left along SRPC

5. Decrease in AD = Down/right along SRPCPL
LRAS π% .
SRAS
SRPC .  . . P π    P1 π1 AD
AD1   YF Y
GDPR u un u%
C↓, IG↓, G↓ and/or XN↓
.: AD  .: GDPR↓ & PL↓ .: u%↑ & π%↓ .: down/right along SRPC

6. .: SRAS  .: GDPR↑ & PL↓ .: u%↓ & π%↓ .: SRPC  (Disinflation)
SRAS  = SRPC 
SRAS
SRPC PL π%
LRPC
LRAS . .
SRAS1
SRPC1   . . P π   P1 π1 AD   Y YF
GDPR un u u%
Inflationary Expectations↓, Input Prices↓, Productivity↑, Business Taxes↓, Subsidies↑, and/or Deregulation
.: SRAS  .: GDPR↑ & PL↓ .: u%↓ & π%↓ .: SRPC  (Disinflation)

7. .: SRAS  .: GDPR↓ & PL↑ .: u%↑ & π%↑ .: SRPC  (Stagflation)
SRAS  = SRPC 
SRAS1
SRPC1 π% PL
LRAS
LRPC
SRAS
SRPC . .   . . P1
π 1   P π AD   Y1 YF
GDPR un u1 u%
Inflationary Expectations↑, Input Prices↑, Productivity↓, Business Taxes↑, Subsidies↓, and/or Increased Regulation
.: SRAS  .: GDPR↓ & PL↑ .: u%↑ & π%↑ .: SRPC  (Stagflation)

8. The Long-Run Phillips Curveπ%
LRPC
un% u%
Note: Natural rate of unemployment is held constant

9. The Long-Run Phillips Curve (LRPC)
Because the Long-Run Phillips Curve exists at the natural rate of unemployment (un), structural changes in the economy that affect un will also cause the LRPC to shift.
Increases in un will shift LRPC 
Decreases in un will shift LRPC 
The key to understanding shifts in the Phillips curve is inverse relationships

10. Reconciling the LRPC and SRPC
In the long-run, the inflation rate at B (π1 %)
becomes the new expected inflation rate (π1%), and the economy returns to the natural rate of unemployment (point C). (All input costs have increased) SRAS moves left
SRPC (π %)
LRPC
π %
uN% A π% B C 
π1 % 
SRPC (π1 %)
In the short-run, assuming the policy is successful, inflation occurs and unemployment decreases as the economy moves from A to B. u% u%
Assume that either the government or the central bank enacts an expansionary policy to reduce the unemployment rate below its natural rate at point A. AD to the right

11. Reconciling the LRPC and SRPC
In the long-run, the inflation rate at B (π1 %)
becomes the new expected inflation rate (π1%), and the economy, once again, returns to the natural rate of unemployment (all input costs have decreased)
(point C).
SRPC (π %)
LRPC
π %
uN% A π%  B C 
π1 %
SRPC (π1 %)
In the short-run, assuming the policy is successful, disinflation occurs and unemployment increases as the economy moves from A to B. u%
Now assume that either the government or the central bank enacts a contractionary policy to reduce inflation from its current rate at point A u%

12. Relating Phillips Curve to AS/AD
Changes in the AS/AD model can be seen in the Phillips Curves
An easy way to understand how changes in the AS/AD model affect the Phillips Curve is to think of the two sets of graphs as mirror images.

13. Summary
There is a short-run trade off between u% & π%. This is referred to as a short-run Phillips Curve (SRPC)
In the long-run, no trade-off exists between u% & π%. This is referred to as the long-run Phillips Curve (LRPC)

14. Summary (cont.)
The LRPC exists at the natural rate of unemployment (un).
un ↑ .: LRPC 
un ↓ .: LRPC 

15. ΔC, ΔIG, ΔG, and/or ΔXN = Δ AD = Δ along SRPC
AD  .: GDPR↑ & PL↑ .: u%↓ & π%↑ .: up/left along SRPC
AD  .: GDPR↓ & PL↓ .: u%↑ & π%↓ .: down/right along SRPC
Δ Input Prices, Δ Productivity, Δ Business Taxes, Subsidies, and/or Δ Regulation = Δ SRAS = Δ SRPC
SRAS  .: GDPR↑ & PL↓ .: u%↓ & π%↓ .: SRPC 
SRAS  .: GDPR↓ & PL ↑ .: u%↑ & π%↑.: SRPC 