Phillips Curve
Short-run tradeoff between inflation and unemployment.
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What this graph shows
The Phillips curve shows the short-run tradeoff between inflation and unemployment. The short-run Phillips curve (SRPC) slopes downward: low unemployment comes with high inflation, and high unemployment with low inflation. This is the flip side of the AD/AS model, since a rightward AD shift both lowers unemployment and raises inflation, moving up along the SRPC.
The long-run Phillips curve (LRPC) is a vertical line at the natural rate of unemployment. In the long run there is no tradeoff: the economy returns to the natural rate no matter the inflation rate, because expectations adjust. If expected inflation changes, the whole short-run curve shifts up or down, which is how the model explains stagflation and why permanently lower unemployment cannot be bought with higher inflation.
How to read it
The horizontal axis is the unemployment rate and the vertical axis is the inflation rate, both in percent. The downward-sloping SRPC gives the short-run menu of inflation-unemployment combinations, and the vertical LRPC marks the natural rate where the two curves cross. Moving along the SRPC shows short-run demand changes, while shifting the whole curve up or down shows a change in expected inflation. In the long run the economy sits on the vertical LRPC at the natural rate whatever the inflation rate.
Three things to try
- Move the current point up and to the left along the SRPC. Inflation rises as unemployment falls, showing the short-run tradeoff that comes from a demand-driven boom.
- Shift the SRPC upward to raise expected inflation. At the natural rate of unemployment inflation is now higher, the setup for stagflation where both inflation and unemployment can be elevated.
- Change the natural rate to move the vertical LRPC. The SRPC re-anchors at the new natural rate, showing that long-run unemployment is set by structural factors, not by the inflation rate.
Common questions
Why is the long-run Phillips curve vertical?
The long-run Phillips curve is vertical at the natural rate of unemployment because, once inflation expectations fully adjust, unemployment returns to its natural rate no matter the inflation rate. There is no permanent tradeoff between inflation and unemployment in the long run.
How does the Phillips curve relate to the AD/AS model?
They tell the same story from different angles. A rightward AD shift raises the price level and real GDP, which shows up on the Phillips curve as higher inflation and lower unemployment, a move up along the short-run curve. Both models share the natural rate as their long-run anchor.
What shifts the short-run Phillips curve?
A change in expected inflation shifts the entire short-run Phillips curve. If workers and firms expect higher inflation, the SRPC shifts up, so any given unemployment rate now comes with higher inflation. Supply shocks can shift it too.
Phillips Curve: key terms
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