Short-run Phillips curve

Definition

The short-run Phillips curve illustrates the inverse relationship between inflation and unemployment in the short term. It suggests that as inflation rises, unemployment tends to decrease, and vice versa, reflecting the trade-off policymakers face when trying to manage the economy. This curve is based on the idea that people may not immediately adjust their expectations about inflation, allowing for this temporary trade-off.

5 Must Know Facts For Your Next Test

1. The short-run Phillips curve can shift due to supply shocks, such as sudden increases in oil prices that raise production costs and inflation.
2. Expectations about future inflation can affect the position of the short-run Phillips curve; if people expect higher inflation, the curve may shift up.
3. In the short run, policymakers may exploit the trade-off between inflation and unemployment by using monetary or fiscal policy.
4. The concept gained prominence in the 1970s when stagflation challenged the traditional view of the Phillips curve, showing that high inflation and high unemployment could occur simultaneously.
5. While the short-run Phillips curve suggests a negative relationship between inflation and unemployment, this relationship may weaken or disappear in the long run.

Review Questions

• How does the short-run Phillips curve illustrate the trade-off between inflation and unemployment for policymakers?
  • The short-run Phillips curve illustrates that policymakers can make decisions that impact inflation and unemployment in opposite directions. For instance, if a government increases spending, it can stimulate economic activity, leading to lower unemployment. However, this increase in demand can also raise prices, resulting in higher inflation. Therefore, policymakers face a dilemma: lowering unemployment often comes at the cost of rising inflation, highlighting the need for careful economic management.
• Evaluate how changes in expectations about future inflation can shift the short-run Phillips curve.
  • Changes in expectations about future inflation significantly impact the short-run Phillips curve's position. If individuals and businesses anticipate higher future inflation, they may adjust their behavior accordingly by demanding higher wages or increasing prices preemptively. This adjustment can lead to an upward shift of the short-run Phillips curve, resulting in higher inflation rates at any given level of unemployment. Understanding this dynamic is crucial for policymakers who aim to maintain stable economic conditions.
• Analyze the implications of stagflation on the traditional understanding of the short-run Phillips curve.
  • Stagflation challenges the traditional understanding of the short-run Phillips curve by presenting a scenario where both inflation and unemployment rise simultaneously. This phenomenon indicates that the trade-off depicted by the Phillips curve may not hold true during certain economic conditions. As seen in the 1970s, stagflation prompted economists to reconsider existing models and highlight factors like supply shocks or structural changes in the economy. This analysis underscores that economic relationships are complex and can change based on broader conditions.

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 trade-off between inflation and unemployment.

Aggregate demand:

Aggregate demand is the total demand for all goods and services in an economy at a given overall price level and in a given time period.

Stagflation:

Stagflation occurs when an economy experiences stagnant growth, high unemployment, and high inflation simultaneously, challenging traditional economic theories.