– Okay.

In this series of video lectures

we are going to go ahead and talk about what’s called

the Phillips Curve. And the Phillips Curve is

something that economists use to look

at the relationship between unemployment and inflation

because those are two things that people care about a lot. You know, if you sort of ask

people how the economy is doing, likely they would sort

of look at these two things first to think

about how the economy is doing. And the Phillips Curve is

typically going to be a graph that looks something like this. And this was all sort of discovered just

as a sort of fact before people had a real good

theoretical explanation for it. So it was discovered

as an empirical fact before people had a good

explanation. And in particular

what people noticed was when we had relatively

high unemployment, we tended to have relatively

low inflation. And when we tended to have

relatively low unemployment, we tended to have relatively

high inflation. And roughly this point over here

corresponds to a recession, and this point over here corresponds

to some kind of boom. And, you know, there might

have been a whole series of different observations here, and the Phillips Curve

would be sort of the line that passes best

through that cloud of points. So this was all discovered in

the early or mid 20th century. So early 1940’s to 1950’s. So this is sort

of early Keynesian period. So Keynesian economics really gets invented

during The Great Depression and rises into prominence

after the end of World War II. So what’s going on here? Well, we can integrate

this with our aggregate demand, aggregate supply framework. So remember an aggregate demand,

aggregate supply model. We have the overall price level

on the vertical axis there, and GDP on the horizontal

access here. and let’s suppose we think about long-run aggregate

supply being at this level, and then we’re going to go ahead and have a short

run aggregate supply curve and an aggregate demand curve, and then we can go ahead

and think about down in this corner what’s going

on with the Phillips Curve. So remember that if GDP equals

long run aggregate supply, then unemployment equals the natural rate

or NAIRU. So this point A,

our Goldilocks point here corresponds to

unemployment equal to its NAIRU. And typically the economy experiences some

background level of inflation, say three percent. And let’s set posed

that this NAIRU– this NAIRU unemployment rate is

six percent. So the point A in this diagram

is this point A in that diagram. If there is an increase

in aggregate demand, then, of course, what happens is, prices rise. So the inflation rate is higher. And there’s also

an increase in GDP. And when there’s

an increase in GDP, firms hire more workers

to produce that extra output. So unemployment goes down, say from six percent

to four percent. So this point B

in this diagram corresponds to this point B in that diagram. If there had been a fall

in aggregate demand instead, then we would

have had a fall in GDP, thus a rise in unemployment, say to eight percent, and the price level

would have fallen. So– so inflation would have been lower,

say one percent. So this point C

in the aggregate demand, aggregate

supply model diagram corresponds to this point C

in the Phillips Curve model. So key thing here, changes in aggregate

demand cause movements along the Phillips Curve. And just to be clear

because we’re going to make this more complicated

in just a second, the short run Phillips Curve. And in particular an increase

in aggregate demand causes us to move left

along the Phillips Curve, and a decrease in aggregate

demand causes us to move right along the Phillips Curve.