Unit 5

Philips curve (PC): represents relationship between unemployment and inflation. 

• There is a trade off between inflation and unemployment in the short run. 
• In the short run, inflation increases as the economy expands.
• During recession, unemployment rises because the economy expands.

Long Run Philips Curve (LRPC): occurs at a natural rate of unemployment.

• represented by a vertical line
• no trade off between unemployment and inflation in the long run.
• the economy produces at the full employment level.
• LRPC will only shift if LRAS shifts

Supply Shocks: rapid and significant increase in resource cost 

Stagflation: This is where inflation and unemployment increases at the same time. 

Shifts of the PC: 

• if AD changes, we will move points on the SRPC.
• if SRAS changes, we will move SRPC.
• SRPC is equivalent to the rate of unemployment. 
• the natural rate of unemployment = frictional, structural, and seasonal unemployment.

Misery Index: 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 Philips curve. 
• Also occurs when AD decreases
• Deflation: general decline in the price level
• Hyperinflation: when an economy experiences a high and unusual rate of inflation which can decrease the value of the currency.
• "Reaganomics" or "Supply-Side economics" - to determine the level of inflation, unemployment rates, and economic growth. 
• supply side economist  support policies that promote GDP growth by arguing that high marginal tax rates along with the current system of transfer payments. (Unemployment compensation and welfare programs provide disincentives to work, invest, and undertake entrepreneurial adventures.)
• Laffer curve: 
• depicts a theoretical relationship between tax rates and government revenues from increasing from zero to some maximum level and then decreasing.  
• 1st criticism: empirical evidence suggests that the impact of tax rates on incentives to work, save, and invest are small. 
• 2nd criticism: tax cut also increases demand which can fuel inflation. 
• 3rd criticism: when the economy is actually located on the laffer curve is difficult to determine.