Short Run Phillips Curve Flashcards, test questions and answers

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What is Short Run Phillips Curve?

The short-run Phillips curve is an economic concept that suggests there is a trade-off between inflation and unemployment. This means that when inflation increases, unemployment decreases and vice versa. The idea of the short-run Phillips curve is based on the theory of Keynesian economics, which states that there is a relationship between aggregate demand (AD) and prices. When AD increases, prices increase as well, resulting in higher inflation. On the other hand, when AD decreases, prices decrease as well, resulting in lower inflation. The short-run Phillips curve explains this relationship between inflation and unemployment by showing how higher levels of aggregate demand can lead to increased employment as firms start producing more goods to meet consumer demand and thus hire more workers to help with production needs. At the same time, these firms may need to raise their wages in order to keep up with rising costs associated with production (such as raw materials). As wages increase due to rising labor costs businesses will be forced to pass those cost increases onto consumers through higher prices; this results in a general rise in price level or inflation rate. In contrast, when aggregate demand falls then firms are forced to cut back on production due to decreased consumer spending resulting in fewer jobs for workers causing an increase in unemployment rates. To combat this effect some countries have adopted policies such as increasing government spending or cutting taxes so that consumers have more money available for purchases leading again to increased economic activity which would bring down the unemployment rate while pushing up the overall price level or rate of inflation again creating another point on the Short Run Phillips Curve graph.. Overall it can be seen that high levels of employment are typically associated with higher levels of inflation while periods of low employment coincide with lower rates of inflation; this phenomenon being referred to as the trade off between unemployment and inflation which is graphically represented by what we call today.