Unit V: Phillips Curve

Unit V: Phillips Curve: Represents the relationship between unemployment and inflation 


Long Run Phillips curve: Occurs at the natural rate of unemployment. (4-5%) represented by a vertical line 
No trade off between unemployment and inflation in the long run - the economy produces at the full employment level. Will only shift if the LRAS curve shifts 
The major LRPC assumption is that more worker benefits create higher natural rate and fewer worker benefits create lower natural rates. 

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). 
Supply side economics: it is the belief That the as curve will determine levels of inflation, unemployment, and economic growth. 
To increase the economy you would shift the as curve to the right. 
Supply side economists focus on the marginal tax rate-(Amount paid on the last dollar earned or on each additional dollar earned)
Beliefs: Lower taxes are an incentive for a business to invest in the economy and that lower taxes are an incentive for workers to work hard thereby becoming more productive. Lower taxes are incentives for people to increase savings and therefore create lower interest rates which causes an increase in business investment. 
They support policies that promote GDP growth by arguing that high marginal tax rates along with the current system of transfer payments such as unemployment compensation or welfare programs provide disincentives to work invest innovate and undertake entrepanuer ventures 
Known as Reaganomics. 

Ladder curve : a Tradeoffs between tax rates and government revenue. Used to support the supply side argument. As tax rates increase from zero tax revenues increase from zero to some number and then decline. 

Three criticisms of the ladder curve: 
1. Research suggests that the impact of tax rates on incentives to work save and invest are small. 
2. Tax Cuts also increase demand which can fuel inflation thus creating a situation where demand exceeds supply. 
3. Where the economy is actually located on the curve is difficult to determine. 








Short Run Phillips Curve: there is a trade off between inflation and unemployment. SRPC has relevance to Okun's law. Since wages are sticky, inflation changes move the points on the SRPC. If inflation persists and the expected rate of inflation rises, then the entire SRPC moves upward which causes a situation called stagflation. If inflation expectations drop due to new technology or economic growth then SRPC moves downward. 

Aggregate Supply Shock: causes both the rate of inflation and the rate of unemployment to increase. It is a rapid and significantly increase in resource cost. 



The misery Index: is a combination of inflation and unemployment in a any given year, single digit misery is good.