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Unit 3:Aggregate Demand and Supply and Fiscal Policy
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The Phillips CurveShows tradeoff between inflation and
unemployment.What happens to inflation and unemployment
when AD increase?
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3
In general, there is an inverse relationship between unemployment and inflation
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Inflation
4
SRPC
Short Run Phillips Curve
Unemployment2% 9%
1%
5%
When the economy is overheating, there is low unemployment but high inflation
When there is a recession, unemployment is high but
inflation is low
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Inflation
5
SRPC
Short Run Phillips Curve
Unemployment2% 9%
1%
5%
What happens when AS falls causing stagflation?Increase in unemployment and inflation
SRPC1
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Inflation
6
Short Run vs. Long Run
Unemployment2% 9%
1%
5%
3%
5%
Long Run Phillips Curve
In the long run there is no tradeoff between inflation and unemployment
The LRPC is vertical at the Natural Rate of
Unemployment
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The Phillips Curve in real life isn’t like the textbook
AD/AS and the Phillips Curve
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Price Level
9
AD
AS
AD/AS and the Phillips Curve
GDPRQY
PLe
LRAS Inflation
SRPC
UnemploymentUY
LRPC
Show what happens on both graphs if AD increase
AD1
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Price Level
10
AD
AS
AD/AS and the Phillips Curve
GDPRQY
PLe
LRAS Inflation
SRPC
UnemploymentUY
LRPC
Correctly draw the LRPC and SRPC with the recessionary gap. What happens when AD falls?
AD1
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Price Level
11
AD
AS
AD/AS and the Phillips Curve
GDPRQY
PLe
LRAS Inflation
SRPC
UnemploymentUY
LRPC
Correctly draw the LRPC and SRPC at full employment. What happens when AS falls?
AS1
SRPC1
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Price Level
12
AD
AS
AD/AS and the Phillips Curve
GDPRQY
PLe
LRAS Inflation
SRPC
UnemploymentUY
LRPC
Correctly draw the LRPC and SRPC with an recessionary gap. What happens when AS goes up?
AS1
SRPC1
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Price Level
13
SRAS
GDPRQY
LRAS Inflation
SRPC
UnemploymentUY
LRPC
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AD
Price Level
14
SRAS
GDPRQY
LRAS Inflation
SRPC
UnemploymentUY
LRPC
AD2
AD3
PLe
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AD
Price Level
15
SRAS
GDPRQY
LRAS Inflation
SRPC
UnemploymentUY
LRPCAS1
PLe
AS2
SRPC1
SRPC2
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AD
Price Level
16
AS
GDPRQY
LRAS Inflation
SRPC
UnemploymentUY
LRPCAS2
PLe
SRPC1AD2
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2008 Audit Exam
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Analyzing the Economy Graphically
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Use the following models to show full employment, a recessionary gap, and an
inflationary gap.
1. PPC2. Business Cycle3. AD/AS4. Phillips Curve
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The Good, the Bad, and the Ugly
Unemployment Inflation GDP Growth
Good 6% or less 1%-4% 2.5%-5%
Worry 6.5%-8% 5%-8% 1%-2%
Bad 8.5 % or more 9% or more .5% or less
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