5.2 The Phillips Curve

a. Define (using graphs as appropriate) the short-run Phillips curve and the long-run Phillips curve. b. Explain (using graphs as appropriate) short-run and long-run equilibrium in the Phillips curve model.

• The short-run trade-off between inflation and unemployment can be illustrated by the downward-sloping short-run Phillips curve (SRPC).
• An economy is always operating somewhere along the SRPC.
• The long-run relationship between inflation and unemployment can be illustrated by the long-run Phillips curve (LRPC), which is vertical at the natural rate of unemployment.
• Long-run equilibrium corresponds to the intersection of the SRPC and the LRPC.
• Points to the left of long-run equilibrium represent inflationary gaps, while points to the right of long-run equilibrium represent recessionary gaps.
• Enduring understanding MOD-3: The Phillips curve model is used to represent the relationship between inflation and unemployment and to illustrate how macroeconomic shocks affect inflation and unemployment.

Explain (using graphs as appropriate) the response of unemployment and inflation in the short run and in the long run.

• Demand shocks correspond to movement along the SRPC.
• Supply shocks correspond to shifts of the SRPC.
• Factors that cause the natural rate of unemployment to change will cause the LRPC to shift.
• Enduring understanding MOD-3: The Phillips curve model is used to represent the relationship between inflation and unemployment and to illustrate how macroeconomic shocks affect inflation and unemployment.