The Phillips Curve Quiz

PDF page 306: In the 1950s, A.W. Phillips, an economist at the London School of Economics, was studying the Keynesian analytical framework. The Keynesian theory implied that during a recession inflationary pressures are low, but when the level of output is at or even pushing beyond potential GDP, the economy is at greater risk for inflation. Phillips analyzed 60 years of British data and did find that tradeoff between unemployment and inflation, which became known as the Phillips curve. Figure 11.19 shows a theoretical Phillips curve, and the following Work It Out feature shows how the pattern appears for the United States.

PDF page 306: Figure 11.19 A Keynesian Phillips Curve Tradeoff between Unemployment and Inflation A Phillips curve

PDF page 306: illustrates a tradeoff between the unemployment rate and the inflation rate. If one is higher, the other must be lower. For example, point A illustrates a 5% inflation rate and a 4% unemployment. If the government attempts to reduce inflation to 2%, then it will experience a rise in unemployment to 7%, as point B shows.

PDF page 306: In the 1950s, A.W. Phillips, an economist at the London School of Economics, was studying the Keynesian analytical framework. The Keynesian theory implied that during a recession inflationary pressures are low, but when the level of output is at or even pushing beyond potential GDP, the economy is at greater risk for inflation. Phillips analyzed 60 years of British data and did find that tradeoff between unemployment and inflation, which became known as the Phillips curve. Figure 11.19 shows a theoretical Phillips curve, and the following Work It Out feature shows how the pattern appears for the United States.

PDF page 306: In the 1950s, A.W. Phillips, an economist at the London School of Economics, was studying the Keynesian analytical framework. The Keynesian theory implied that during a recession inflationary pressures are low, but when the level of output is at or even pushing beyond potential GDP, the economy is at greater risk for inflation. Phillips analyzed 60 years of British data and did find that tradeoff between unemployment and inflation, which became known as the Phillips curve. Figure 11.19 shows a theoretical Phillips curve, and the following Work It Out feature shows how the pattern appears for the United States.

PDF page 306: illustrates a tradeoff between the unemployment rate and the inflation rate. If one is higher, the other must be lower. For example, point A illustrates a 5% inflation rate and a 4% unemployment. If the government attempts to reduce inflation to 2%, then it will experience a rise in unemployment to 7%, as point B shows.

PDF page 306: illustrates a tradeoff between the unemployment rate and the inflation rate. If one is higher, the other must be lower. For example, point A illustrates a 5% inflation rate and a 4% unemployment. If the government attempts to reduce inflation to 2%, then it will experience a rise in unemployment to 7%, as point B shows.

PDF page 306: illustrates a tradeoff between the unemployment rate and the inflation rate. If one is higher, the other must be lower. For example, point A illustrates a 5% inflation rate and a 4% unemployment. If the government attempts to reduce inflation to 2%, then it will experience a rise in unemployment to 7%, as point B shows.

PDF page 305: The simplified AD/AS model that we have used so far is fully consistent with Keynes’s original model. More recent research, though, has indicated that in the real world, an aggregate supply curve is more curved than the right angle that we used in this chapter. Rather, the real-world AS curve is very flat at levels of output far below potential (“the Keynesian zone”), very steep at levels of output above potential (“the neoclassical zone”) and curved in between (“the intermediate zone”). Figure 11.18 illustrates this. The typical aggregate supply curve leads to the concept of the Phillips curve.

PDF page 305: The simplified AD/AS model that we have used so far is fully consistent with Keynes’s original model. More recent research, though, has indicated that in the real world, an aggregate supply curve is more curved than the right angle that we used in this chapter. Rather, the real-world AS curve is very flat at levels of output far below potential (“the Keynesian zone”), very steep at levels of output above potential (“the neoclassical zone”) and curved in between (“the intermediate zone”). Figure 11.18 illustrates this. The typical aggregate supply curve leads to the concept of the Phillips curve.

PDF page 305: equilibrium Ek, in the Keynesian zone at the SRAS curve's far left, small shifts in AD, either to the right or the left, will affect the output level Yk, but will not much affect the price level. In the Keynesian zone, AD largely determines the quantity of output. Near the equilibrium En, in the neoclassical zone, at the SRAS curve's far right, small shifts in AD, either to the right or the left, will have relatively little effect on the output level Yn, but instead will have a greater effect on the price level. In the neoclassical zone, the near-vertical SRAS curve close to the level of potential GDP (as represented by the LRAS line) largely determines the quantity of output. In the intermediate zone around equilibrium Ei, movement in AD to the right will increase both the output level and the price level, while a movement in AD to the left would decrease both the output level and the price level.

PDF page 305: equilibrium Ek, in the Keynesian zone at the SRAS curve's far left, small shifts in AD, either to the right or the left, will affect the output level Yk, but will not much affect the price level. In the Keynesian zone, AD largely determines the quantity of output. Near the equilibrium En, in the neoclassical zone, at the SRAS curve's far right, small shifts in AD, either to the right or the left, will have relatively little effect on the output level Yn, but instead will have a greater effect on the price level. In the neoclassical zone, the near-vertical SRAS curve close to the level of potential GDP (as represented by the LRAS line) largely determines the quantity of output. In the intermediate zone around equilibrium Ei, movement in AD to the right will increase both the output level and the price level, while a movement in AD to the left would decrease both the output level and the price level.

PDF page 307: During the 1960s, economists viewed the Phillips curve as a policy menu. A nation could choose low inflation and high unemployment, or high inflation and low unemployment, or anywhere in between. Economies could use fiscal and monetary policy to move up or down the Phillips curve as desired. Then a curious thing happened. When policymakers tried to exploit the tradeoff between inflation and unemployment, the result was an increase in both inflation and unemployment. What had happened? The Phillips curve shifted. The U.S. economy experienced this pattern in the deep recession from 1973 to 1975, and again in back-to-back recessions from 1980 to 1982. Many nations around the world saw similar increases in unemployment and inflation. This pattern became known as stagflation. (Recall from The Aggregate Demand/Aggregate Supply Model that stagflation is an unhealthy combination of high unemployment and high inflation.) Perhaps most important,