Unit 3: Aggregate Demand and Supply and Fiscal Policy 1 Copyright ACDC Leadership 2015

The Phillips Curve Shows tradeoff between inflation and unemployment. What happens to inflation and unemployment when AD increase? Copyright ACDC Leadership 2015

3 In general, there is an inverse relationship between unemployment and inflation Copyright ACDC Leadership 2015

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 Copyright ACDC Leadership 2015

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 Copyright ACDC Leadership 2015

The Phillips Curve in real life isn’t like the textbook

AD/AS and the Phillips Curve Copyright ACDC Leadership 2015

AD Price Level 8 SRAS GDP R QYQY LRAS Inflation SRPC Unemployment UYUY AD 2 AD 3 PL e Copyright ACDC Leadership 2015 Shifts in AD and the SRPC Show what happens on both graphs if AD changes. Increase? Decrease? AD shifts cause movement along the SRPC.

AD Price Level 9 SRAS GDP R QYQY LRAS Inflation SRPC Unemployment UYUY AS 1 PL e AS 2 SRPC 1 SRPC 2 Copyright ACDC Leadership 2015 Shifts in AS and the SRPC Show what happens on both graphs if AS changes. Decrease? Increase? AS shifts cause shifts of the SRPC.

AD Price Level 10 AS GDP R QYQY LRAS Inflation SRPC Unemployment UYUY LRPC AS 2 PL e SRPC 1 AD 2 Copyright ACDC Leadership 2015 What happens as we transition to the long run? AD/AS and the Phillips Curve

Inflation 11 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 Copyright ACDC Leadership 2015

The Long-Run Phillips Curve Annual Rate of Inflation (Percent) Unemployment Rate (Percent) PC LR PC 3 PC 2 PC 1 a1a1 b1b1 a2a2 a3a3 b2b2 b3b3 c3c3 c2c

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 13 Copyright ACDC Leadership 2015

The Misery Index Rate of Inflation +Rate of Unemployment =Misery Index

Stagflation A period with simultaneously high, or rising, rates of both unemployment and inflation..D.D Stagflation!

2008 Audit Exam

Taxes and Aggregate Supply Supply-side economics Tax incentives to work Tax incentives to save and invest The Laffer curve Tax Rate (Percent) Tax Revenue (Dollars) 100 m 0 n l m Laffer Curve Maximum Tax Revenue 35-17

Taxes and Aggregate Supply Criticisms of the Laffer curve –Taxes, incentives, and time Would higher taxes cause people to work less? Why? –Inflation and higher real interest rates If aggregate demand moves faster –Is there a perfect number? Lower taxes worked for Reagan… –Recession ended, tax revenues increased –Why? –AD? AS? –LRAS? 35-18

Analyzing the Economy Graphically 19 Copyright ACDC Leadership 2015 Review!!

Use the following models to show full employment, a recessionary gap, and an inflationary gap. 1. PPC 2. Business Cycle 3. AD/AS 4. Phillips Curve Copyright ACDC Leadership 2015