AP Econ Quest Phillip's Curve

What does a recessionary gap look like using a mainstream economy in an AS/AD curve?

How would this recessionary gap be fixed in a mainstream economy?

Fiscal policy would:

• Increase gov’t spending

• Decrease taxes

Which will increase inflation and decrease unemployment → increase AD + POE *tradeoff exists

Monetary policy would:

• decrease interest rates

which will increase inflation and decrease unemp → increasing IG, AD, & POE *tradeoff exists

In a self-correcting economy, what happens in the SR and LR due to recession?

SR: AD & POE decreases (inf. decreases, unemp. increases) → tradeoff

• Business profits fall (pts 1-2)

• wages are fixed, so they wouldn’t change

LR: Recession causes layoffs (pts 2-3)

• Wages & PUPS decrease, SRAS increases (P decreases, OE increases)

• Inf. & unemp. decreases → no tradeoff

What does the AS/AD curve look like in a self-correcting economy during a recession?

Unanchored expectations within the public

• people don’t know what to expect in the economy so they don’t know what to do with their money

What is a classical economy?

• No gov’t

• self-correcting

• LR always at Qf

What is a keynesian economy?

• Gov’t involvement

• No self-correcting

• Fiscal policy

What is a mainstream economy?

• Gov’t involvement

• Not self-correcting

• Fiscal + monetary policy

What is a tradeoff?

Inverse relationship between inflation and unemployment

What does an inflationary gap look like in a AS/AD curve?

How can this inflationary gap be fixed with policy in a mainstream economy?

Fiscal policy:

• Decrease gov’t spending

• Increase taxes

• This will decrease AD & POE

Inf. will decrease and unemp. will increase → tradeoff exists

Monetary policy:

• Increase in int. rates

• Decrease in Ig

• This will decrease AD, P & OE → increase in unemp. decrease in inf.

Tradeoff exists → pts 2-1

*well-anchored inflation expectations and back to Qf

What happens in demand pull inflation in a self-correcting economy?

SR: increase in AD, P, & OE

• increase in inf. decrease in unemp. → tradeoff

• Business profits increase

• wages fixed

LR: inflation causes workers to demand more money

• wages & PUPS increases and SRAS decreases

• P increases, OE decreases

• inf & unemp. increases → no tradeoff

What does demand pull inflation looks like in a self-correcting economy?