AP Macroeconomics: Phillips Curve (Short?Run vs Long?Run, Shifts, Trade?off)

AP Macroeconomics – Phillips Curve (Short?Run vs Long?Run, Shifts, Trade?off)

AP Macroeconomics – Phillips Curve (Short?Run vs Long?Run, Shifts, Trade?off)

What This Is

The Phillips Curve depicts the inverse relationship between inflation and unemployment in an economy. In the short run (SRPC) a lower unemployment rate usually comes with higher inflation, while the long?run Phillips Curve (LRPC) is vertical at the natural rate of unemployment (also called the NAIRU). Understanding the curve lets you predict how monetary or fiscal policy will affect price stability and joblessness—exactly the kind of analysis AP?Mac asks for in multiple?choice and free?response questions.

Real?world example: In the early 2000s the Federal Reserve kept interest rates low to combat a recession. The policy pushed aggregate demand up, lowering unemployment but also raising inflation—an illustration of a movement along the short?run Phillips curve.

Key Terms & Formulas

• Short?Run Phillips Curve (SRPC): Graph with inflation rate (vertical axis) vs. unemployment rate (horizontal axis); downward?sloping.
• Long?Run Phillips Curve (LRPC): Same axes as SRPC but vertical line at the natural rate of unemployment (U*).
• Natural Rate of Unemployment (U*): The unemployment level when the labor market is in equilibrium; not affected by short?run demand?side policies.
• NAIRU (Non?Accelerating Inflation Rate of Unemployment): Synonym for U*; the unemployment rate at which inflation is stable.
• Expectations?augmented Phillips Curve: ? = –? (U – U*) where-= actual inflation, = expected inflation,-> 0 measures how strongly unemployment affects inflation.
• Adaptive Expectations: ? = (people expect next period’s inflation to equal this period’s actual inflation).
• Supply?Shock Shift: A leftward shift of the SRPC (higher inflation at every unemployment level) caused by a negative aggregate?supply shock (e.g., oil price spike).
• Demand?Shock Shift: A rightward shift of the SRPC (lower inflation at every unemployment level) caused by a positive aggregate?demand shock (e.g., expansionary fiscal policy).
• Policy Trade?off: In the short run, policymakers can choose a point along the SRPC (lower unemployment-higher inflation), but in the long run the trade?off disappears because the LRPC is vertical.
• Monetary Policy Tool – Discount Rate: The Fed’s short?term interest rate; lowering it shifts AD right, moving the economy down the SRPC (lower unemployment, higher inflation).

Step?by?Step / Process Flow (Typical AP Problem)

1. Identify the shock (e.g., “the government raises the federal minimum wage”).
2. Determine the direction of the Phillips?curve shift:
3. If the shock raises production costs-SRPC shifts left (higher inflation).
4. If the shock boosts aggregate demand-SRPC shifts right (lower inflation).
5. Draw the graph:
6. Plot the original SRPC (downward?sloping).
7. Add the new SRPC (parallel shift left or right).
8. Mark the natural?rate vertical line (LRPC).
9. Locate the initial equilibrium point (where the economy is on the original SRPC).
10. Show the movement to the new equilibrium on the shifted SRPC; read the new unemployment and inflation values.
11. Explain the short?run trade?off and why, in the long run, the economy will return to the LRPC (adjusting expectations, wages, etc.).

Common Mistakes

• Mistake: Saying the LRPC is “flat” because inflation can still change with unemployment.
  Correction: The LRPC is vertical; in the long run unemployment is fixed at U* and inflation is determined by monetary policy, not by the unemployment rate.

• Mistake: Confusing a movement along the SRPC with a shift of the SRPC.
  Correction: A change in aggregate demand moves the economy along the SRPC; a supply?side shock (e.g., oil price rise) shifts the SRPC.

• Mistake: Ignoring expectations and using the “original” Phillips curve after a large inflation shock.
  Correction: When inflation expectations change, the expectations?augmented Phillips curve must be used; the SRPC will shift upward as rises.

• Mistake: Believing that a lower unemployment rate always means a better outcome.
  Correction: In the short run lower unemployment may come with higher inflation; the optimal policy depends on the inflation target and the cost of price instability.

• Mistake: Mixing up the axes—drawing unemployment on the vertical axis.
  Correction: Inflation is always on the vertical axis; unemployment on the horizontal axis.

AP Exam Insights

1. Multiple?Choice Focus: ?Questions often ask you to identify whether a policy causes a movement along the SRPC or a shift of the curve (e.g., “expansionary fiscal policy will…”).
2. Free?Response Prompt: ?Typical FRQs require you to draw the SRPC and LRPC, label the natural?rate line, and explain the short?run trade?off versus the long?run outcome after a given shock.
3. Tricky Distinction: ?AP loves to test the difference between “change in demand for goods” (AD shift) and “change in the price level” (movement along AD). The same logic applies to the Phillips curve: policy?induced demand changes move you along the SRPC, while cost?push shocks shift the SRPC.
4. Expectations Emphasis: ?If a question mentions “workers now expect higher inflation,” you must incorporate and show an upward shift of the SRPC.

Quick Check Questions

1. MC: The Federal Reserve lowers the discount rate, causing AD to increase. Which of the following occurs on the Phillips curve?
2. A) SRPC shifts left
3. B) SRPC shifts right
4. C) Movement down along the SRPC

5. D) Movement up along the SRPC
   Answer: C – Lower rates boost AD, reducing unemployment and moving the economy down the existing SRPC (higher inflation, lower unemployment).

6. FRQ?style: A sudden rise in oil prices raises production costs for firms. Explain the effect on the short?run Phillips curve and the long?run unemployment rate.
   Answer: The oil?price shock shifts the SRPC left (higher inflation at every unemployment level). In the short run unemployment may fall or rise depending on the magnitude of the shift, but in the long run the economy returns to the vertical LRPC at the natural rate, so the long?run unemployment rate is unchanged.

7. MC: If workers’ inflation expectations double, the Phillips curve will:

8. A) Remain unchanged because expectations affect only the LRPC.
9. B) Shift upward (to the left).
10. C) Shift downward (to the right).
11. D) Rotate clockwise.
    Answer: B – Higher expected inflation raises actual inflation for any given unemployment, shifting the SRPC upward (left).

Last?Minute Cram Sheet (10 One?Liners)

1. SRPC = downward?sloping (? vs. U).
2. LRPC = vertical line at the natural rate of unemployment (U*).
3. ? = –? (U – U*) – the expectations?augmented Phillips equation.
4. Cost?push shock-SRPC shifts left (higher-for any U).
5. Demand?pull shock-SRPC shifts right (lower-for any U).
6. In the short run, policymakers face a trade?off: lower U-higher ?.
7. In the long run, no trade?off; the economy returns to U* (LRPC).
8. Adaptive expectations: ? = – past inflation shapes future expectations.
9. “Supply increases” means the curve shifts right, not up; a price change causes a movement along the curve.
10. Monetary expansion (lower discount rate)-AD right-move down the SRPC (lower U, higher ?).