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Unit 3: Aggregate Demand and Supply and Fiscal Policy

Unit 3: Aggregate Demand and Supply and Fiscal Policy. 1. The Phillips Curve. Shows tradeoff between inflation and unemployment. What happens to inflation and unemployment when AD increase?. In general, there is an inverse relationship between unemployment and inflation. 3.

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Unit 3: Aggregate Demand and Supply and Fiscal Policy

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  1. Unit 3:Aggregate Demand and Supply and Fiscal Policy 1

  2. The Phillips Curve Shows tradeoff between inflation and unemployment. What happens to inflation and unemployment when AD increase?

  3. In general, there is an inverse relationship between unemployment and inflation 3

  4. Short Run Phillips Curve When the economy is overheating, there is low unemployment but high inflation Inflation When there is a recession, unemployment is high but inflation is low 5% 1% SRPC 2% 9% Unemployment 4

  5. Short Run Phillips Curve What happens when AS falls causing stagflation? Increase in unemployment and inflation Inflation 5% SRPC1 1% SRPC 2% 9% Unemployment 5

  6. Short Run vs. Long Run What happens when AD increases? What happens in the long run? Long Run Phillips Curve Inflation In the long run, wages and resource prices increase. AS falls. SRPC shifts right. 5% 3% SRPC1 1% SRPC 2% 5% 9% Unemployment 6

  7. Short Run vs. Long Run In the long run there is no tradeoff between inflation and unemployment Long Run Phillips Curve Inflation 5% The LRPC is vertical at the Natural Rate of Unemployment 3% 1% 2% 5% 9% Unemployment 7

  8. Short Run vs. Long Run What happens when AD falls? What happens in the long run? Long Run Phillips Curve Inflation 5% In the long run wages fall and there is no tradeoff between inflation and unemployment 3% 1% SRPC SRPC1 2% 5% 9% Unemployment 8

  9. AD/AS and the Phillips Curve

  10. AD/AS and the Phillips Curve Show what happens on both graphs if AD increase LRPC Price Level LRAS Inflation AS PLe AD1 SRPC AD QY GDPR UY Unemployment 10

  11. AD/AS and the Phillips Curve Correctly draw the LRPC and SRPC with the recessionary gap. What happens when AD falls? Price Level LRAS LRPC Inflation AS PLe SRPC AD AD1 QY GDPR UY Unemployment 11

  12. AD/AS and the Phillips Curve Correctly draw the LRPC and SRPC at full employment. What happens when AS falls? Price Level LRAS LRPC Inflation AS1 AS PLe SRPC1 AD SRPC QY GDPR UY Unemployment 12

  13. AD/AS and the Phillips Curve Correctly draw the LRPC and SRPC with an recessionary gap. What happens when AS goes up? Price Level LRAS LRPC Inflation AS AS1 PLe SRPC AD SRPC1 QY GDPR UY Unemployment 13

  14. SRAS LRPC LRAS Inflation Price Level SRPC UY Unemployment QY GDPR 14

  15. SRAS LRPC LRAS Inflation Price Level PLe AD2 AD SRPC AD3 UY Unemployment QY GDPR 15

  16. AS1 SRAS LRPC LRAS Inflation Price Level AS2 PLe SRPC1 AD SRPC SRPC2 UY Unemployment QY GDPR 16

  17. AS AS2 LRPC LRAS Inflation Price Level PLe SRPC1 AD2 AD SRPC UY Unemployment QY GDPR 17

  18. Analyzing the Economy Graphically 18

  19. Use the following models to show full employment, a recessionary gap, and an inflationary gap. • PPC • Business Cycle • AD/AS • Phillips Curve 19

  20. The Good, the Bad, and the Ugly Unemployment Inflation GDP Growth Good 6% or less 1%-4% 2.5%-5% Worry 6.5%-8% 5%-8% 1%-2% Bad 8.5 % or more 9% or more .5% or less 20

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