Short Run Phillips Curve: Videos & Practice Problems

The short run Phillips curve (SRPC) illustrates the inverse relationship between inflation and unemployment. It shows that when inflation increases, unemployment tends to decrease, and vice versa. This relationship is derived from the aggregate demand and aggregate supply model. When aggregate demand increases, GDP rises, leading to lower unemployment but higher inflation. Conversely, when aggregate demand decreases, GDP falls, resulting in higher unemployment but lower inflation. The SRPC is downward sloping, indicating that efforts to reduce inflation often lead to higher unemployment and that reducing unemployment can lead to higher inflation. This inverse relationship is crucial for understanding macroeconomic policy and stabilization efforts.

Aggregate demand (AD) significantly impacts the short run Phillips curve (SRPC). When AD increases, it leads to higher GDP and lower unemployment, but also higher inflation. This movement along the SRPC shows a decrease in unemployment and an increase in inflation. Conversely, when AD decreases, GDP falls, leading to higher unemployment and lower inflation. This results in a movement along the SRPC where unemployment rises and inflation falls. These dynamics highlight the inverse relationship between inflation and unemployment, making it challenging to manage both simultaneously through macroeconomic policies.

Controlling both inflation and unemployment simultaneously is difficult due to the inverse relationship illustrated by the short run Phillips curve (SRPC). When policymakers attempt to reduce inflation, it often leads to higher unemployment, as lower aggregate demand reduces GDP and the need for workers. Conversely, efforts to reduce unemployment by increasing aggregate demand can lead to higher inflation. This trade-off means that achieving low inflation and low unemployment at the same time is challenging, requiring careful balancing of macroeconomic policies to stabilize the economy without exacerbating either issue.

The short run Phillips curve (SRPC) has significant implications for macroeconomic policy. It highlights the trade-off between inflation and unemployment, suggesting that policies aimed at reducing one can increase the other. For instance, contractionary policies to curb inflation may lead to higher unemployment, while expansionary policies to reduce unemployment can cause higher inflation. Policymakers must carefully balance these objectives, often prioritizing one based on current economic conditions. Understanding the SRPC helps in designing effective stabilization policies, such as adjusting interest rates or government spending, to manage economic fluctuations without causing adverse effects on either inflation or unemployment.

The short run Phillips curve (SRPC) can shift due to changes in expectations and supply shocks. If inflation expectations rise, the SRPC shifts upward, meaning higher inflation for any given level of unemployment. Conversely, if inflation expectations fall, the SRPC shifts downward. Supply shocks, such as changes in oil prices or technological advancements, can also shift the SRPC. A negative supply shock, like a sudden increase in oil prices, shifts the SRPC upward, leading to higher inflation and unemployment. Positive supply shocks, such as technological improvements, can shift the SRPC downward, reducing both inflation and unemployment.