Guys I’m having a hard time understanding the long vs short run effects on the philips curve of expected and unexpected inflation etc… How do you go about solving these ones ? Thanks and good luck everyone
easy…its economics…you gotta draw it on paper, that simple. with the LAS curve, because thats hard to achieve, we shift around it creating the inflationary/recessionary gaps. if unexpected is greater then expected (inflationary), the SR phillips curve will be to the left of the LAS as unemployment has dropped and inflation is higher. likewise, the opposite holds. draw it down and play with it.
thanks, but that doesn’t really help…I’m trying to read but its not sinking in
No worries. Think of it in parallel with AD and LRAS curves. The superficial difference is instead of comparing the Price Level (Y axis) with Real GDP (X axis), you’re comparing Inflation (Y axis) with Unemployment (X axis). The central assumption is that unemployment and inflation are inversely related. Just as LRAS is a straight line in the long run (ie, full-employment GDP is essentially a fixed amount), long-run Phillips curve is basically a “fixed” level at the level that is where GDP is at potential (“natural unemployment” or “full employment”). The intersection of the short-run and long-run curves meet is what defines the inflation expectation (ie, if expected inflation is 8%, then SR Phillips curve = LR Phillips curve when inflation on the Y axis is 8%). The issue is then with the deviations from the long-run curve. If unemployment decreases *below* the “natural” / “full” rate, then you will move leftwards along the short-run curve and inflation will rise to a level higher than expected (makes sense >> as greater numbers are working, aggregate demand is rising and forcing up prices). On the other hand, if unemployment increases *above* the “natural” / “full” rate, then you will move rightwards along the short-run curve and inflation will fall to a level below that of expectations (as more unemployment means less aggregate demand, which forces prices lower). Hopefully this graph helps: - http://en.wikipedia.org/wiki/Phillips_curve#NAIRU_and_rational_expectations
Phillips curve is a simpler way of understanding inflation expectation that varies with unemployment. It provides a way to study changes to both simultaenously. When inflation expectation changes (y-axis), short run PC will shift to meet the new expectation however, when natural unemployment changes, LRPC will shift to the new unemployment (st line on x-axis) and SRPC will shift to maintain the inflation at the new LRPC unemployment.