Unit 5

Phillips Curve

• represents the relationship between unemployment and inflation
• there is a trade-off between inflation and unemployment in the short term
• in the short run, inflation increases as the economy expands
• during a recession, unemployment increases because the economy slows down
• Long Run  Phillips Curve (LRPC)
• occurs at the natural rate of unemployment
• represented by a vertical line
• there is no trade-off between unemployment and inflation in the long run
• the economy produces at full employment output level
• LRPC will only shift if LRAS shofts
• Supply Shocks
• a rapid and significant increase in resource cost
• Stagflation
• where inflation and unemployment increase at the same time
• shifts of the Phillips Curve
• if AD changes, we will move points on the SRPC
• if SRAS changes, we will move the SRPC
• LRPC is equivalent to the natural rate of unemployment
• natural rate of unemployment = frictional, seasonal, and structural unemployment
• Misery Index
• a combination of inflation and unemployment in a given year
• single-digit misery is good
• Disinflation
• a reduction in the inflation rate from year to year, which can be seen in the long-run Phillips Curve
• this also occurs when aggregate demand declines
• Deflation - a general decline in the price level
• Hyperinflation - when an economy experiences a high and unusual rates of inflation, which can decrease the value of the local currency

Supply-Side Economics

• changes in AS, not AD
• to determine the level of inflation, unemployment rate, and economic growth
• a.k.a. Reaganomics
• supply-side economists support policies that promote GDP growth by arguing that high marginal tax rates along with the current system of transfer payments (unemployment compensations and welfare programs) provide disincentives to work, invest, and underline entrepreneurial ventures

Laffer Curve

• depicts a fear radical relationship between tax rates and government revenue
• as tax rates increase from zero, tax revenues increase from zero to some maximum level and then declines
• 3 criticisms of Laffer Curve
1. empirical evidence suggests that the impact of tax rates on incentives to work, save, and invest are small
2. tax cuts also increase demand which can fuel inflation
3. where the economy is actually located on the Laffer Curve is difficult to determine