The Phillips curve

The Phillips curve

Theoru of expectations.

Short-run and long-run aggregate supply

- Short-run: An increase in AD in the up-sloping portion of AS curve can be expected to increase both the price level and real output.

- BUT

- To analyze longer time period we need to extend the analysis of AS to account for changes in nominal wages which are in response to change

Short-run and long-run: definitions.

· The short run is the period in which nominal wages (and other input prices) remain fixed as the price level changes.

· Reasons:

- Workers may not immediately be aware of the extent to which inflation has changed their real wages. They may not adjust their SL and wage demands;

- Many employees are hired under fixed-wage contracts.

- The long run - a period in which nominal wages are fully responsive to changes in the price level.

- Workers gain full information about price-level changes and determine how these changes have affected their real

Short-run aggregate supply

This curve

- An i

Long-run aggregate supply

nominal wages in the long run are fully responsive to changes in the price level.

- A price-level rise increases nominal wages and thus shifts the short-run AS curve leftward.

- A decrease in the price-level reduces nominal wages and thus shifts the short-run AS curve rightward.

- After such adjustments, the economy reaches equilibrium at points b and c.

- Thus, the long-run AS curve is vertical.

The phillips curve

- Shows a stable relationship between the rate of inflation and the unemployment rate.

The phillips curve: criticism

- This curve is available for short-run period.

- In the long -run the economy automatically gravitates to its natural rate of unemplo

The theories of expectation (natural-rate theory)

- The adaptive expectations(ожиданий) theory

- The rational expectations theory

The adaptive expectations theory

- Assumes people form their expectations of future inflation on the basis of previous and present rates of inflation. When people do, the U rate return to the natural rate.

- The long-run Phillips Curve is therefoe vertical,

The rational expectations theory

- Assumes that increases in nominal wages lag behind increases in the price level because the increases in the price level are not anticipated.

- Workers will anticipate the inflationary effects of monetary and fiscal policy and will build these expectations into their wage demands.

- As a result, not even a short-run Phillips curve will exist.

- The economy will simply move along its vertical long-run Phillips Curve when government undertakes expansionary policies.