5 Steps to a 5 AP Macroeconomics 2019

Aggregate Demand and Aggregate Supply ❮ 121

The Long-Run Phillips Curve

The AD and AS model presumes that the long­run AS curve is vertical and located at full
employment. As a result, the Phillips curve in the long run is also vertical at the natural rate
of employment. You might recall that the natural rate of employment is the unemployment

rate where cyclical unemployment is zero. Suppose this occurs at a measured unemploy­
ment rate of 4 percent. Figure 9.22 illustrates the long­run Phillips curve.

Figure 9.22

Figure 9.21

SRPC 0

Unemployment

Rate (%)

Inflation

Rate (%)

SRAS is

decreasing

SRAS is

increasing

SRPC 1

SRPC 2

Phillips

Curve (SR)

Unemployment

Rate (%)

Inflation

Rate (%) Phillips

Curve (LR)

4%

Expectations

The idea that there is, in the short term, an inverse relationship between inflation and
unemployment, and in the long term, unemployment is always at the natural rate can be
confusing. The reason is that sometimes a gap exists between the actual rate of inflation and
the expected rate of inflation. Inflationary expectations play a role here in the derivation of
the long­run Phillips curve. Figure 9.23 illustrates this concept with an example.
The expected inflation rate is 2 percent at a 4 percent natural rate of unemployment
(point a). If AD unexpectedly rises, this drives up the rate of inflation to 5 percent, and as a
result, firms are earning higher profits. Firms respond with more hiring, and this temporar­
ily drops the unemployment rate to 2 percent (point b). This is seen as a movement along
the short­run PC above from a to b.