MacroIQ · AP Macroeconomics

Lesson 12: The Short-Run Phillips Curve

Macroeconomics · Unit 5 (20–30%)

Objectives

Draw the short-run Phillips curve and explain the inverse inflation-unemployment relationship
Translate AD-AS events into Phillips-curve language: AD shifts move you ALONG the SRPC; SRAS shifts SHIFT it
Locate any economy's AD-AS position as a point on the SRPC

Hook

In 1958, economist A.W. Phillips plotted a century of British wage inflation against unemployment and found a stubborn pattern: when one was high, the other was low. Policymakers read it as a menu — buy lower unemployment, pay with higher inflation. For a decade the menu worked; then the 1970s served up high inflation and high unemployment simultaneously, and the menu caught fire. Both the pattern and its betrayal are on your exam. This lesson builds the short-run Phillips curve, shows that it's just the AD-AS model wearing different axes, and explains exactly when it holds (demand shocks) and when it shifts (supply shocks). Next lesson: why the menu vanishes entirely in the long run.

Core Concepts

The curve

The short-run Phillips curve (SRPC) plots inflation (y-axis) against unemployment (x-axis) and slopes downward: lower unemployment comes with higher inflation, and vice versa — in the short run, for demand-driven fluctuations.

Why the tradeoff exists — it's AD-AS in disguise: - AD shifts right along SRAS → output ↑ (unemployment ↓) and price level ↑ (inflation ↑). High-pressure economy: tight labor markets bid up wages and prices. - AD shifts left → output ↓ (unemployment ↑) and inflation ↓ (or disinflation).

Every point on the SRPC corresponds to a possible AD-SRAS intersection. The two graphs are the same information: AD-AS speaks (price level, output); the Phillips curve speaks (inflation, unemployment). Output up = unemployment down; price level accelerating = inflation up.

The golden translation rules

Demand shocks (AD shifts) = movements ALONG the SRPC. AD right → slide up-left along SRPC (lower UE, higher inflation). AD left → slide down-right (higher UE, lower inflation). The SRPC itself does not move.
Supply shocks (SRAS shifts) = SHIFTS of the SRPC. - Negative supply shock (oil spike; SRAS left): inflation ↑ AND unemployment ↑ — a point up and to the right of the old curve. SRPC shifts right/up. That's stagflation, the combination that broke the 1970s menu. - Positive supply shock (productivity boom; SRAS right): both fall → SRPC shifts left/down — the happy version.
Changed inflation expectations also shift the SRPC (higher expected inflation → SRPC up/right) — that's the bridge to Lesson 13, where expectations dissolve the tradeoff entirely.

Apply It: Translate each event into SRPC language: (1) A fiscal stimulus closes a recessionary gap. (2) An energy crisis strikes. (3) Cheap new solar power cuts production costs economy-wide. → (1) movement up-left along the SRPC; (2) SRPC shifts right — higher inflation at every unemployment rate; (3) SRPC shifts left.

Reading gaps on the SRPC

Mark the natural rate of unemployment (NRU) on the x-axis (Lesson 13 will hang a vertical curve there): - Economy at a point with unemployment below the NRU → inflationary gap territory (high inflation, hot economy). - Unemployment above the NRU → recessionary gap (low inflation or deflation, slack economy). - At the NRU → full employment; inflation equals whatever people currently expect.

Disinflation's price tag (preview)

To cut inflation, a central bank tightens: AD left → slide down-right along the SRPC → unemployment rises above the NRU for a while. That temporary pain — output and jobs sacrificed per point of inflation reduction — is the cost of disinflation. How long the pain lasts depends on how quickly expectations adjust (Lesson 13's whole plot).

Graph Focus

[GRAPH: Short-Run Phillips Curve — demand shock (movement along)
X-axis: Unemployment rate (%)
Y-axis: Inflation rate (%)
Curve 1: SRPC, downward-sloping
Point A at (5% UE, 2% inflation) — initial position at the NRU
Movement: expansionary policy shifts AD right in the companion AD-AS graph →
economy slides ALONG the SRPC to point B at (3.5% UE, 4% inflation)
Reading: demand events never move the curve — only the point]

[GRAPH: SRPC — negative supply shock (shift)
X-axis: Unemployment rate (%)
Y-axis: Inflation rate (%)
Curves: SRPC₁ shifting right/up to SRPC₂
Points: A at (5%, 2%) on SRPC₁ → C at (7%, 5%) on SRPC₂
Reading: oil spike shifts SRAS left → BOTH inflation and unemployment rise —
no point on SRPC₁ can represent this; the curve itself moved]

AP labeling requirements: axes are inflation rate and unemployment rate — NOT price level and output (mixing axes across the twin graphs is the classic penalty); label SRPC; for shifts show SRPC₁ → SRPC₂ with arrow; when pairing with an AD-AS graph, make the two stories agree (AD right ↔ slide up-left; SRAS left ↔ SRPC right).

Common Traps

Shifting the SRPC for a demand shock. Fiscal stimulus, monetary easing, confidence swings — all are movements ALONG the curve. Only supply shocks and expectation changes shift it.
Wrong axes. Inflation (not price level) and unemployment (not real GDP). The Phillips curve is the AD-AS model re-graphed, not copied.
Stagflation location. Higher inflation + higher unemployment cannot be a point on the original SRPC — the curve must have shifted right. If a question says both rose, the answer involves a shift.
Direction of "right." SRPC shifting "right" (or "up") is the bad shift — more inflation at every unemployment rate. Don't import micro's "right = more = good" instinct.
Assuming the tradeoff is permanent. The SRPC holds while inflation expectations are fixed. The exam's Lesson 13 follow-up — "in the long run…?" — has a different answer (vertical curve, no tradeoff).

Practice Problems

Question 1

The short-run Phillips curve illustrates the inverse relationship between:

(A) the price level and real GDP
(B) real and nominal interest rates
(C) inflation and unemployment
(D) government spending and taxes
(E) saving and investment

Question 2

An economy moves along its SRPC from a point of low inflation and high unemployment to a point of higher inflation and lower unemployment. The most likely cause is:

(A) an increase in aggregate demand
(B) a negative supply shock
(C) a decrease in aggregate demand
(D) a rightward shift of SRAS
(E) a fall in inflation expectations

Question 3

A sharp, economy-wide increase in energy prices is represented on the Phillips curve diagram as:

(A) a movement up along the SRPC
(B) a movement down along the SRPC
(C) a leftward shift of the SRPC
(D) no change — energy prices affect only AD-AS
(E) a rightward (upward) shift of the SRPC

Question 4

Stagflation appears on a Phillips curve graph as:

(A) a movement along the SRPC toward lower unemployment
(B) a point with BOTH higher inflation and higher unemployment, reachable only if the SRPC shifted right
(C) a movement down the SRPC
(D) a point below the original SRPC
(E) the SRPC becoming horizontal

Question 5

In AD-AS language, a movement DOWN along the SRPC (lower inflation, higher unemployment) corresponds to:

(A) SRAS shifting right
(B) LRAS shifting left
(C) AD shifting right
(D) AD shifting left
(E) SRAS shifting left

Question 6

A productivity boom lowers production costs across the economy. On the Phillips curve diagram this appears as:

(A) a movement up along the SRPC
(B) a leftward (downward) shift of the SRPC — lower inflation at every unemployment rate
(C) a rightward shift of the SRPC
(D) a steeper SRPC
(E) a movement down along an unchanged SRPC

Question 7

An economy sits on its SRPC at unemployment equal to the natural rate. Expansionary monetary policy will move the economy:

(A) down the SRPC to lower inflation
(B) off the graph entirely
(C) up-left along the SRPC — unemployment below the NRU, inflation above its previous rate
(D) to a rightward-shifted SRPC
(E) to lower inflation and lower unemployment simultaneously

Question 8

Which pair of graphs tells a CONSISTENT story?

(A) AD shifts right in AD-AS; the economy slides up-left along the SRPC
(B) AD shifts right; the SRPC shifts right
(C) SRAS shifts left; the economy slides down the SRPC
(D) SRAS shifts left; the SRPC shifts left
(E) AD shifts left; the economy slides up-left along the SRPC

Question 9

An economy is at a point on its SRPC where unemployment is well ABOVE the natural rate. In AD-AS terms, the economy is experiencing:

(A) an inflationary gap
(B) long-run equilibrium
(C) a positive supply shock
(D) hyperinflation
(E) a recessionary gap

Question 10

Rising inflation expectations shift the SRPC:

(A) leftward, lowering inflation at every unemployment rate
(B) not at all — expectations affect only the long-run curve
(C) into a vertical position immediately
(D) rightward (upward) — higher inflation at every unemployment rate
(E) downward along the horizontal axis

Question 11

A central bank decides to reduce inflation from 8% to 3% through contractionary policy. According to the SRPC, the short-run cost is:

(A) a permanent fall in potential output
(B) higher inflation expectations
(C) a temporary rise in unemployment above the natural rate as the economy slides down the SRPC
(D) an immediate rightward SRPC shift
(E) no cost — disinflation is free in the short run

Question 12

Which event moves the economy along an UNCHANGED short-run Phillips curve?

(A) an oil embargo
(B) a large increase in government infrastructure spending
(C) a rise in expected inflation
(D) a economy-wide productivity surge
(E) a collapse in the capital stock

Question 13

In year 1, the economy has 5% unemployment and 2% inflation. In year 2, it has 7% unemployment and 6% inflation. A student concludes the economy moved along its SRPC. The best evaluation is:

(A) incorrect — both variables rose, which an unchanged downward-sloping SRPC cannot produce; the curve must have shifted rightward (e.g., a negative supply shock)
(B) correct — any two points define a movement along
(C) correct — inflation and unemployment always move together
(D) incorrect — the SRPC slopes upward, so this is a movement along it
(E) incorrect — Phillips curves apply only to the long run

FRQ Practice (Long)

The economy of Kestria is initially at full employment with unemployment at its natural rate of 5% and inflation of 2%.

(a) Draw a correctly labeled short-run Phillips curve for Kestria. Label the initial point A at (5%, 2%).

(b) A global shipping crisis sharply raises input costs throughout Kestria's economy. (i) On a correctly labeled AD–SRAS–LRAS graph, show the effect of the crisis on Kestria's price level and output. (ii) On your Phillips curve graph, show the effect of the crisis. Label Kestria's new position point B.

(d) Kestria's central bank responds with expansionary monetary policy to return output to full employment. (i) On your Phillips curve graph, show the effect of this policy. Label the new position point C. (ii) What is the cost of this policy choice, in Phillips-curve terms?

(e) Instead of (d), suppose the central bank did nothing and the shipping crisis eventually resolved, restoring the original cost structure. Describe what happens to the SRPC.

Model response & scoring (8 points)

(a) 1 pt: Axes inflation (y) / unemployment (x); downward SRPC₁; point A at (5%, 2%).
(b) 2 pts: (i) SRAS shifts left on AD-AS: price level rises, real output falls (1). (ii) SRPC shifts right/up to SRPC₂; point B above and right of A — e.g., (7%, 4%) (1).
(c) 1 pt: Both inflation and unemployment rose — stagflation.
(d) 2 pts: (i) Movement along SRPC₂ up and to the left from B to C: unemployment falls back toward 5%, inflation rises further (1). (ii) The cost is even higher inflation — demand policy can restore employment only by accepting more inflation on the shifted curve (1).
(e) 2 pts: With input costs restored, SRAS shifts back right (1); the SRPC shifts back left/down toward its original position — inflation and unemployment can both fall (1).

Show answer key & explanations

(g) Answer Key

1. C. The SRPC's axes: inflation vs. unemployment. A: those are AD-AS axes — the same model, different clothes. B/D/E: different relationships entirely. Fix: Phillips curve = (unemployment, inflation) space; AD-AS = (output, price level) space.

2. A. Up-left along the SRPC = hotter economy = AD right (output up → UE down; prices accelerating → inflation up). B: a supply shock shifts the curve. C: wrong direction. D: SRAS right shifts SRPC left, not a movement. E: falling expectations shift it left. Fix: Demand events slide the point; the direction along the curve tracks AD's direction.

3. E. Cost-push shock: inflation rises at every unemployment rate — SRPC right/up (mirror of SRAS left). A/B: movements are demand stories. C: that's the positive shock. D: the Phillips curve is AD-AS translated — it must respond. Fix: SRAS left ↔ SRPC right; SRAS right ↔ SRPC left. Learn the mirror.

4. B. Both variables worse = northeast of the old curve = the curve moved right. A/C: movements trade one variable for the other — they can't worsen both. D: below the curve is the better region. E: slope games aren't the answer. Fix: If inflation AND unemployment rose, stop looking for a movement — the SRPC shifted.

5. D. Lower inflation + higher unemployment = cooling demand = AD left. A: SRAS right shifts the SRPC itself left. B: LRAS isn't in this story. C: backwards. E: SRAS left shifts SRPC right. Fix: Translate along-the-curve slides directly into AD shifts, same direction as the temperature of the economy.

6. B. Lower costs across the economy = SRAS right = SRPC left/down: better inflation at every unemployment rate. A/E: no demand event occurred. C: that's the negative shock. D: slope isn't the concept tested. Fix: Positive supply shocks are the free lunch: both curves improve (SRAS right, SRPC left).

7. C. Stimulus from the NRU: slide up-left — unemployment dips below natural, inflation rises. A: expansion doesn't lower inflation. B: nonsense. D: demand policy never shifts the SRPC. E: that combination needs a supply improvement. Fix: Demand stimulus buys lower unemployment at the price of higher inflation — a slide, not a shift.

8. A. AD right = hotter = up-left along SRPC. Consistent. B: demand shifts don't move the SRPC. C/D: SRAS left must shift SRPC right, not slide or shift it left. E: AD left slides down-right, not up-left. Fix: Check consistency by translating both graphs into (inflation, unemployment) outcomes and comparing.

9. E. Unemployment above natural = slack = output below potential = recessionary gap. A: that's below-natural unemployment. B: long-run equilibrium sits exactly at the NRU. C: a positive shock would lower both variables, not park UE high. D: nothing suggests runaway inflation. Fix: Compare the point's unemployment to the NRU: above = recessionary, below = inflationary.

10. D. Expected inflation gets built into wage demands → costs rise at every UE rate → SRPC up/right. A: falling expectations do that. B: expectations are exactly what move the short-run curve (and anchor the long-run one). C: verticality is the long-run curve's property. E: not a meaningful transformation. Fix: Expectations are the SRPC's elevation setting: expect more inflation, get a higher curve.

11. C. Disinflation = AD restraint = slide down-right along the SRPC: unemployment temporarily above natural. A: potential output isn't destroyed by demand policy. B: expectations fall eventually — that's the cure. D: no shock occurred. E: the slide's pain is the whole policy debate. Fix: The short-run price of lower inflation is a spell of above-natural unemployment.

12. B. Government spending is a demand event → movement along the SRPC. A/C/D/E: supply shocks, expectation changes, productivity, and capital destruction all shift the curve. Fix: Sort events supply-vs-demand FIRST; demand slides, supply (and expectations) shift.

13. A. Unemployment ↑ AND inflation ↑ is northeast movement — impossible along one downward-sloping curve; a rightward shift (negative supply shock or higher expectations) explains it. B: two points only lie on one curve if the tradeoff direction holds. C: they move inversely along a fixed curve. D: the SRPC slopes downward. E: it's the short-run curve by name. Fix: Two data points moving the same direction = shifted curve; opposite directions = possible movement along.

Exam tip: Every Phillips-curve question is a translation exercise. Build the dictionary: AD right = slide up-left; AD left = slide down-right; SRAS left = SRPC right; SRAS right = SRPC left. Four entries, total coverage. When a question gives you two years of data, check the directions first — same-direction changes mean the curve moved. Next lesson: the long-run Phillips curve stands up vertical, and the inflation-unemployment menu closes for good.

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