Phillips Curve

Phillip's curve

Short run

• Represents the relationship between employment and inflation
• Trade off between inflation and unemployment that only occurs in the short run 
• There is an inverse relationship between unemployment and inflation 
• Has relevance to Okun's law. 
• Since wages are sticky, inflation changes, move the points on the SRPC
• If inflation persists and the expected rate of inflation rises, then the entire SRPC moves upward due to stagflation 
• If inflation expectations drop, due to new technology or economic growth, then the SRPC moves downward 

Long run

• Long run Phillips curve occurs at the natural rate of unemployment  
• Represented by a vertical line
• No trade off between unemployment and inflation in the long run, which means that the economy produces at the full employment level 
• Will only shift if the LRAS curve shifts
• Structural, seasonal, and frictional unemployment 
• Full employment is around 4-5% 
• Major LRAC assumption is that more worker benefit create higher natural rates. Fewer worker benefits create lower natural rates. 
• Whatever shifts PPC, will shift LRAS

• Aggregate supply shocks cause both the rate of inflation and the rate of unemployment to increase (rapid and significant increase in resource cost)

The long-run Phillips curve (LRPC)

• Because the long-run Phillips curve exists at the natural rate of unemployment (Un), structural changes in the economy that affect Un will also affect cause the LRPC to shift.
• Increases in Un will shift LRPC >
• Decreases in Un will shift LRPC <
• Increase in AD = up/left movement along SRPC
• Decrease in AD = down/right along SRPC
• SRAS > = SRPC < 
• SRAS < = SRPC > (stagflation) 

Stagflation 

• When inflation and unemployment increase simultaneously
• Baby boom 1946-1964
• Women's movement 
• Civil rights movement
• Vietnam war ends
• All embargo of 1973 and 1979

Disinflation

• Reduction in the inflation rate from year to year 
• Occurs when aggregate demand declines

Deflation

• General drop in the price level

Misery index 

• Combination of inflation and unemployment in any given year single digit misery is good

Supply side economics

• Belief that the AS curve will determine levels of inflation, unemployment, and economic growth 
• To increase the economy the AS curve will have to shift to the right which will benefit the company first
• Supply side economists focus on marginal tax rates 
• Amount paid on the last dollar earned, or on each additional dollar earned
• Lower taxes are incentives for businesses to invest in our economy
• Lower taxes are incentives for workers to work more and harder, thereby becoming more productive 
• Lower taxes are incentives for people to increase savings and therefore create lower interest rates which will increase business investment
• Supply side economists support policies that promote GDP growth by arguing that high marginal tax rates along with our current system pf transfer payments such as unemployment compensation or welfare programs provide disincentives to work, invest, innovate, and undertake entrepreneur ventures 

Reaganomics 

• Lowered the marginal tax rate to get the U.S. out of a recession 
• Deficit

Laffer curve

• Trade off between tax rates and government revenue
• Used to support the supply side argument 
• As tax rates increase from 0, tax revenues increase from 0 to some maximum level and then decline 

Progressive tax rate

• Increases per year
• 37% breakoff point
• No point in working if there are more taxes

3 criticisms

1. Research suggests that the impact of tax rates on incentives to work, invest, and to save are small

2. Tax cuts also increase demand which can fuel inflation and it causes demand to exceed supply

3. Where the economy is actually located on the curve is yet to be determined