Short-Run Phillips Curve

Definition

The short-run Phillips curve is a graphical representation of the inverse relationship between the rate of inflation and the level of unemployment in an economy over the short-term. It suggests that policymakers can choose to have either lower unemployment or lower inflation, but not both simultaneously, in the short run.

5 Must Know Facts For Your Next Test

1. The short-run Phillips curve is downward sloping, indicating that there is a trade-off between inflation and unemployment in the short run.
2. The position of the short-run Phillips curve depends on factors such as expectations of future inflation, supply shocks, and the level of aggregate demand in the economy.
3. Policymakers can use expansionary fiscal or monetary policies to shift the short-run Phillips curve and reduce unemployment, but this will come at the cost of higher inflation.
4. The short-run Phillips curve is based on the assumption of sticky prices and wages, which means that they do not adjust immediately to changes in economic conditions.
5. The short-run Phillips curve is a useful tool for policymakers in managing the trade-off between inflation and unemployment, but it does not capture the long-term dynamics of the economy.

Review Questions

• Explain the relationship between the short-run Phillips curve and the level of unemployment in an economy.
  • The short-run Phillips curve depicts an inverse relationship between the rate of inflation and the level of unemployment in an economy. This means that in the short run, policymakers can choose to have either lower unemployment or lower inflation, but not both simultaneously. If the government implements expansionary policies to reduce unemployment, this will lead to higher inflation, as shown by a movement along the downward-sloping short-run Phillips curve. Conversely, if the government pursues policies to lower inflation, this will result in higher unemployment.
• Describe how factors such as expectations of future inflation, supply shocks, and aggregate demand can affect the position of the short-run Phillips curve.
  • The position of the short-run Phillips curve can shift due to various factors. If expectations of future inflation increase, the short-run Phillips curve will shift upward, indicating that a higher rate of inflation is required to achieve a given level of unemployment. Supply shocks, such as a rise in the price of oil or other commodities, can also shift the short-run Phillips curve upward, as they increase production costs and lead to higher inflation. Conversely, an increase in aggregate demand will shift the short-run Phillips curve downward, as it will lead to both higher inflation and lower unemployment. These factors can influence the trade-off between inflation and unemployment that policymakers face in the short run.
• Evaluate the usefulness of the short-run Phillips curve as a policy tool for managing the trade-off between inflation and unemployment, and discuss its limitations in capturing the long-term dynamics of the economy.
  • The short-run Phillips curve is a useful tool for policymakers in managing the trade-off between inflation and unemployment in the short term. It allows them to understand the potential consequences of their policy decisions and make informed choices about whether to prioritize reducing unemployment or lowering inflation. However, the short-run Phillips curve has limitations in capturing the long-term dynamics of the economy. In the long run, the Phillips curve is vertical, indicating that there is no trade-off between inflation and unemployment. This is because in the long run, expectations of inflation adjust, and the economy tends to move towards its natural rate of unemployment, regardless of the level of inflation. Additionally, the short-run Phillips curve does not account for the potential for stagflation, a situation where high inflation coexists with high unemployment. Therefore, while the short-run Phillips curve is a valuable tool for policymakers, it should be used in conjunction with other economic models and indicators to gain a comprehensive understanding of the economy and make effective policy decisions.

Related terms

Phillips Curve: The Phillips curve is an economic model that shows the inverse relationship between the unemployment rate and the rate of inflation in an economy.

Long-Run Phillips Curve: The long-run Phillips curve is vertical, indicating that there is no long-term trade-off between inflation and unemployment.

Inflation: Inflation is the sustained increase in the general price level of goods and services in an economy over time.