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Phillips Curve
Book Ch. (page)

Class Econ 101

Zoom link - Passcode

Date: @August 5, 2019

Topic:

Recall Notes
Note: Each SRPC Two sides of a coin: AS Curve and Phillips Curve
is drawn for a given Slope of LR and SR AS curve
expected inflation π
e

Phillips Curve

negative relationship between unemployment and inflation

indicates a temporary SR tradeoff between inflation and

unemployment

Phillips Curve 1
 Two sides of the same coin:
SR AS and SR Phillips Curve

LR AS and LR Phillips Curve

Phillips Curve 2
 Phillips curve and SR AS break down the classical dichotomy
(i.e. real affects real, nominal affects nominal) in the short run
because it shows that price (nominal) can affect unemployment
(real)

SRAS Function:

Phillips Curve 3
 To derive SRAS curve, assume either sticky prices or imperfect
information.

Sticky-price model:

firms are assumed to be price-setters (violates classical

theory assumption of perfect competition)

firms cannot adjust prices to changes in demand

a below measures sensitivity of desired price p of the firm to

changes in income Y

Phillips Curve 4
 In determining overall price level P, assume two types of firms
(flexible-price and sticky-price).

Imperfect Information model

Assumptions:

each firm produces a single good, consumes many goods

many firms in economy

prices and wages are flexible

Phillips Curve 5
 imperfect information

Implications:

temporary misperceptions regarding prices

if the price of a good increases, the firm/producer would not

immediately know whether it's just the price of the good it
sells that went up or if all prices in the economy went up

Imperfect Information: Allegory of the rice farmer

Phillips Curve 6
 Graphing SRAS in (Y, P) space:

At point A, where LRAS and SRAS intersect, expected price =

actual price (Pe = P0 ). Therefore Y = Ybar

P0 is equilibrium price both in SR and LR when brining in AD

curve below

Notice that when AD increased, at point A' actual price is higher

than expected price, and so output is also higher than natural
rate

As agents notice that demand is higher, they will also update

their price expectation, so expected price will go up to P2 where

Phillips Curve 7
 the new SRAS intersects the new AD. Expected price catches
up to actual price

Deriving SRPC from SRAS

Phillips Curve 8
 Phillips curve equations

In image below, adverse supply shocks increase inflation (lower

supply → higher prices)

SR and LR Phillips curve

In LR, u = un and absence of adverse supply shocks

Phillips Curve 9
 Philippine Phillips Curve

SR vs LR Inflation-Unemployment Tradeoffs
Two main sources of inflation:

adverse supply shocks (cost-push inflation)

when AD is high, Y is high, unemployment will be lower

than natural (demand-pull inflation)

Phillips Curve 10
 What will happen if AD increases?
In image below, the initial SRPC was drawn given expected
inflation πe = 0
When actual inflation is higher than expected inflation, actual
unemployment will be lower than the natural rate

Image above tends to happen when economic managers think

the natural rate of unemployment is actually lower (e.g. u')

Phillips Curve 11
 Painless disinflation - lowering inflation without higher
unemployment, possible to achieve with rational expectations

Unexpected disinflation:

Phillips Curve 12
 Adaptive expectations instead of rational expectations
π− 1 implies inflation from a past period

In equation below, natural rate of unemployment is called

NAIRU

Hysteresis
Natural rate hypothesis:

Phillips Curve 13
 Hysteresis - term used to describe long-lasting influence of
history on the natural rate

📌 SUMMARY:

Phillips Curve 14