Unit 5

Phillips curve

• Represents the relationship between unemployment and inflation
• There is a trade-off between inflation and unemployment in the short term
• In the short run, inflation increases as the economy expands
• During a recession, unemployment increases because the economy slows down

Long Run Phillips Curve (LRPC)

• Occurs at the natural rate of unemployment
• Represented by a vertical line
• There is no trade-off between unemployment and inflation in the long run
• The economy produces at full employment output level
• LRPC will only shift if LRAS shifts

Shifts of the Phillips Curve

• if AD changes, we will move points on the SRPC
• if SRAS changes, we will move the SRPC

Disinflation

• A reduction in the rate from year to year, which can be seen in the long-run Phillip curve
• This also occurs when aggregate demand declines

Deflation

• A general decline in the price level

Hyperinflation

• When an economy experiences a high and unusual rate of inflation, which can decrease the value of the local currency

Supply-side economics 

• Changes in AS not AD to determine the level of inflation, unemployment rates and economic growth
• “Reagonomics”-trickle down effect, lowering taxes
• Supply side economists support policies that promote GDP growth by arguing that high marginal tax rates, along with the current system of transfer payments (these transfer payments: unemployment compensation, welfare programs provide disincentives to work, invest and undertake entrepreneurial ventures.

Laffer curve

• Depicts a theoretical relationship between tax rates and government revenue.
• As tax rates increase from 0, tax revenues increase from 0 to some maximum level, and then decline
• 3 Criticisms: 
• Empirical evidence suggests that the impact of tax rates on incentives to work, save and invest are small   
• Tax cuts also increase demand, which can fuel inflation
• Where the economy is actually located on the laffer curve is difficult to determine