120 ❯ Step 4. Review the Knowledge You Need to Score High
Supply Shocks and the Phillips Curve
We saw that when SRAS shifts to the right, holding AD constant, both the price level and
unemployment rate fall. On the other hand, when SRAS shifts to the left, we get stagflation
because inflation and unemployment rates are both rising. Figure 9.21 shows how supply
shocks shift the Phillips curve inward when SRAS shifts to the right, and outward when
SRAS shifts to the left.
AD 0
Real GDP
Price
Level
PL 0
GDP 0
AD 1
SRAS
AD 2
Figure 9.19
Figure 9.20
The Phillips Curve
The inverse relationship between inflation and the unemployment rate has come to be
known as the Phillips curve and in the shortrun is downward sloping. The shortrun
Phillips curve is drawn in Figure 9.20. Though Figure 9.20 does not show it, the possibil
ity of deflation at extremely high unemployment rates means that the Phillips curve may
actually continue falling below the x-axis.
Phillips
Curve (SR)
Unemployment
Rate (%)
Inflation
Rate (%)
KEY IDEA