Unit 5: The Philips curve and Inflation

The Philips curve shows an inverse relationship between inflation and unemployment.

 The Long-Run Phillips Curve/LRPS

Measures unemployment and inflation.

NRU, or Natural rate of unemployment, is constant;

Because the Long-Run Phillips Curve exist at the natural rate of unemployment, structural changes in the economy that affect unemployment will also cause the LRPC to shift.

Increases in unemployment will shift LRPC to the right

Decreases in unemployment will shift LRPC to the left.

The Short-Run Phillips Curve

SRPC has a tradeoff between inflation and unemployment (when one increases the other decreases). (inverse relationship)

LRPC: There is no tradeoff between inflation and unemployment.

          1. The economy produces at the full employment output level.

          2.It is represented by a vertical line.

          3. It occurs at the natural rate of unemployment.

Natural unemployment rate (NRU)= Frictional +Structural +Seasonal

Full employment = 4-5%

LRAS shifters also shifts LRPC.

The major LRPC assumption is that more worker benefits create higher natural rates and fewer worker benefits create lower natural rates.

The misery index:  A combination of inflation and unemployment in any given year.

Single digit misery is good.

Inflation:

It is the general rise in the price level

Deflation:

A general decline in the price level

Disinflation:

Decrease in the rate of inflation over time

Stagflation:

Unemployment and inflation increasing at the same time.

Laffer Curve

The Laffer Curve demonstrates the relationship between tax rate and government revenue.

Tax rates only raise government revenue to some maximum, then above that maximum, they generate less revenue despite the tax rate being higher.