Phillips Curve and Unemployment-Inflation Tradeoffs in Macroeconomics

Phillips Curve

A graph showing the short-run inverse relationship between inflation and unemployment, caused by changes in aggregate demand that affect how much firms produce, hire, and raise prices.

Short-Run Phillips Curve (SRPC)

A downward-sloping curve that shows the tradeoff between inflation and unemployment when inflation expectations are fixed, caused by changes in aggregate demand such as fiscal policy, monetary policy, consumer spending, or investment.

Long-Run Phillips Curve (LRPC)

A vertical line at the natural rate of unemployment showing no long-run tradeoff between inflation and unemployment, caused by wages and prices adjusting over time as inflation expectations fully change.

Natural Rate of Unemployment (uₙ)

The level of unemployment that exists at full employment (only frictional and structural unemployment), caused by normal job searching, skill mismatches, labor laws, and changes in technology.

Inflation Expectations

What people believe future inflation will be, caused by past inflation trends, government policies, central bank actions, and economic news.

Adaptive Expectations

The idea that people base future inflation expectations on past inflation, caused by observing previous price changes and assuming they will continue.

Rational Expectations

The idea that people use all available information, including government policy, to predict inflation, caused by access to economic data and understanding how policy affects prices.

Movement Along the SRPC

A change in inflation and unemployment on the same curve, caused by changes in aggregate demand such as expansionary or contractionary fiscal and monetary policy.

Shift of the SRPC

A change in the position of the entire curve, caused by changes in inflation expectations, supply shocks, labor costs, or productivity.

Upward Shift of the SRPC

A situation where inflation is higher at every unemployment level, caused by higher expected inflation, rising wages, higher oil or energy prices, or other negative supply shocks.

Downward Shift of the SRPC

A situation where inflation is lower at every unemployment level, caused by lower expected inflation, technological improvements, higher productivity, or lower production costs.

Supply Shock

A sudden change in production costs that affects inflation and unemployment, caused by events like oil price spikes, natural disasters, wars, pandemics, or new regulations.

Stagflation

High inflation and high unemployment occurring at the same time, caused by a negative supply shock that reduces aggregate supply.

Demand-Pull Inflation

Inflation that results from too much demand in the economy, caused by expansionary fiscal policy, expansionary monetary policy, or increases in consumer and business spending.

Cost-Push Inflation

Inflation that results from rising production costs, caused by higher wages, higher energy prices, higher raw material costs, or supply shortages.

Expansionary Policy

Government or central bank actions that increase aggregate demand to reduce unemployment, caused by a recession, slow growth, or high unemployment.

Contractionary Policy

Government or central bank actions that decrease aggregate demand to reduce inflation, caused by an overheated economy or high inflation.

Full Employment

A situation where unemployment equals the natural rate of unemployment, caused by the economy operating at its potential output.

NAIRU (Non-Accelerating Inflation Rate of Unemployment)

The unemployment rate at which inflation remains stable, caused by a balance between labor demand and labor supply with stable wage growth.

Tradeoff (Short-Run)

The inverse relationship between inflation and unemployment, caused by increased labor demand raising wages and production costs, which leads firms to raise prices.