– 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.

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