Short-run phillips curve

Definition

The short-run Phillips curve illustrates the inverse relationship between inflation and unemployment in the economy. It suggests that lower unemployment rates can lead to higher inflation rates, and vice versa, reflecting the tradeoff policymakers face when managing economic conditions.

5 Must Know Facts For Your Next Test

1. The short-run Phillips curve slopes downwards, indicating that as inflation increases, unemployment tends to decrease in the short run.
2. This tradeoff can arise because lower unemployment often leads to increased demand for goods and services, pushing prices up.
3. In the short run, expectations about inflation can adjust, influencing how wage and price-setting behavior affects this tradeoff.
4. Central banks may use policies that target short-run changes in inflation and unemployment based on the Phillips curve relationship.
5. Shifts in aggregate supply, such as from oil price shocks, can lead to movements along or shifts of the short-run Phillips curve, impacting inflation and unemployment dynamics.

Review Questions

• How does the short-run Phillips curve illustrate the tradeoff between inflation and unemployment?
  • The short-run Phillips curve shows that there is an inverse relationship between inflation and unemployment. When unemployment decreases, typically due to increased economic activity, inflation tends to rise as employers compete for fewer workers by offering higher wages. Conversely, when unemployment is high, inflation usually falls because of decreased demand for goods and services. This dynamic creates a tradeoff for policymakers who need to balance these two economic indicators.
• What role do expectations play in influencing the short-run Phillips curve?
  • Expectations about future inflation can significantly impact the short-run Phillips curve. If people expect higher inflation in the future, they may demand higher wages now, which can lead to actual increases in inflation. This adjustment process means that while there may initially be a tradeoff between inflation and unemployment, over time as expectations adjust, the relationship depicted by the short-run Phillips curve may change. This highlights how important it is for policymakers to manage both actual economic conditions and public perceptions.
• Evaluate how external shocks might cause shifts in the short-run Phillips curve and what implications this has for economic policy.
  • External shocks, such as sudden increases in oil prices or global financial crises, can shift the short-run Phillips curve. These shocks can increase production costs, leading to higher inflation even as unemployment rises—a situation known as stagflation. When such shifts occur, policymakers face challenges because traditional methods aimed at controlling inflation could exacerbate unemployment or vice versa. This complexity necessitates more nuanced policy approaches that consider multiple economic factors rather than relying solely on the Phillips curve framework.

Related terms

Long-run Phillips Curve: The long-run Phillips curve represents a vertical line at the natural rate of unemployment, indicating that in the long run, there is no tradeoff between inflation and unemployment.

Aggregate Demand: Aggregate demand refers to the total demand for goods and services within an economy at a given overall price level and in a given time period.

Stagflation: Stagflation is an economic situation characterized by stagnant economic growth, high unemployment, and high inflation, which challenges the traditional Phillips curve tradeoff.