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.