The document discusses the Phillips Curve and the relationship between inflation and unemployment. It notes that in the short-run, there is an inverse relationship where lower unemployment is associated with higher inflation and vice versa. However, in the long-run there is no consistent tradeoff because aggregate supply shocks can cause both inflation and unemployment to rise simultaneously. While adverse shocks can shift the Phillips Curve outward in the short-run, in the long-run the curve will always be vertical as the economy adjusts through factors like declining wages and input prices.

1. The Phillips Curve: Unemployment / Inflation relationship
Generalizations
1. There is a short-run tradeoff between the rate of inflation and the rate of
unemployment.
2. Aggregate Supply shocks cause both the rate of inflation and rate of
unemployment to increase.
3. There is no significant tradeoff between the rate of inflation and rate of
unemployment in the long-run; therefore, in the LR, Phillips Curve is always
vertical.
The Phillips Curve
Demonstrates the inverse relationship between unemployment rates and
inflation rates
Assuming a constant short-run AS curve:
o Inflation rate ↑ → Unepmloyment ↓ (when AD increases, there is a
upward pressure on prices and UE therefore decreases)
o Inflation rate ↓ → Unemployment ↑ (when AD decreases, there is a
downward pressure on prices and UE therefore increases)
o Thus, the relationship is inverse as shown by the graph below:

2. Aggregate Supply Shocks and the Phillips Curve:
Stagflation: when inflation and unemployment rise simultaneously,
resulting in an increase in input cost (The Phillips Curve shifts outward)
Adverse Aggregate Supply Shocks: Sudden large increases in
resource costs (known as supply shock) push short-run aggregate supply
(the PC curve)leftward (such as OPEC in the '70s and '80s)
o These shocks distort the usual inflation-unemployment relationship:
a leftward shift of the short-run aggregate supply pc curve
increases price level and increases the unemployment rate (cost-
push inflation)
Stagflation'sDemise:
o However, in the long term:
 Due to great unemployment, workers accept lower wages, and
firms' costs decrease
 Foreign competition also holds down wages and price hikes
 Input prices is a determinant of AS, therefore when input prices
(wages) decrease, AS will shift to the right
 OPEC etc. loses monopolypower
 A component of laissez-faire economics is the theory that the
economy will self-correct. However, the economy will suffer
great unemployment in the process.
When AD shifts to the right, inflation occurs and real output
increases, thus, it shifts left ALONG the Phillips curve. (increase in
inflation but decrease in UE rate) However, when AS shifts to the
left due to decrease in productivity, and increase is input prices, the
Phillips curve shift rightwards restoring to the natural rate of
unemployment. Thus, the Phillips curve'slongrunisalways vertical.