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Long run and short run Phillips curves - YouTube
Channel: Khan Academy
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let's talk a little bit about the short
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run and long run phillips curve now
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they're named after the economist bill
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phillips who saw in the 1950s what
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looked like an inverse relationship
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between inflation and the unemployment
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rate and he was studying decades of data
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sets in the united kingdom where he saw
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usually when we had high or when the
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united kingdom had high inflation you
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had relatively low unemployment and that
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tended to be when the economy was doing
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well so he would see these data points
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from different years and then he would
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see that when there was a high
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unemployment rate when the economy was a
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little bit slower
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then you had low inflation and so he
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theorized the existence of a curve that
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could describe this relationship maybe
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it looks something
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like this
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and if we take this model or if we
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assume this model then it would hold
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that when the economy is strong you have
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high inflation low unemployment when the
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economy is weak you have high
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unemployment and low inflation
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now you fast forward to the 1970s and
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economists started to see a situation
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where this broke down in the 1970s in
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particular you saw situations of
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stagflation where you had both high
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unemployment and high inflation so it
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didn't seem to fit the phillips curve
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and so economists theorized that okay
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maybe this thing that phillips theorized
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is really just what happens in the short
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run so they said that this is the short
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run phillips curve but they theorize
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that there's actually a long run
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phillips curve as well that describes
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the natural rate of unemployment or the
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natural rate of unemployment you would
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get when the economy is at full
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employment
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and remember full employment doesn't
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mean everyone's employed it just means
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the sustainable rate of employment for
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the country
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and so if we wanted to draw that long
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run phillips curve that economists
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theorized in the 1970s it might look
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something like this
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and when you see it as a vertical line
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like this let me write this long
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run
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phillips curve it shows that over the
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long run the unemployment rate would be
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this value right over here irrespective
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of what's going on with inflation
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and so let's say for this economy our
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natural rate of unemployment is
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4
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and we see that it is associated with
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one percent inflation
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and so you could imagine if there are
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some perturbations to the economy maybe
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the economy gets a little bit overheated
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well then you could get a little bit
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higher inflation and lower unemployment
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or if the economy slows down a little
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bit you could have higher unemployment
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and lower inflation but it should
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gravitate back to the long run phillips
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curve
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but now let's think about this in
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context of our aggregate demand
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aggregate supply model and think about a
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scenario where our short run phillips
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curve could actually shift
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so here we have our typical axes when
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we're thinking about aggregate demand
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and aggregate supply we have real gdp on
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our horizontal axis the price level on
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our vertical axis and so our aggregate
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demand curve might look something like
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this it is downward sloping so let's
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call that our aggregate demand curve and
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then our short run aggregate supply
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curve
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might look something like this
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so as price levels go up in the short
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run people are going willing to produce
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more
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so this is our short run
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aggregate supply and remember when we
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talked about aggregate demand and
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aggregate supply we talked about a
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notion of our full employment output
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which is you could view as the
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sustainable rate of output for an
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economy
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and we can draw that as a vertical line
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so this right over here
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would be
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our long run
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aggregate supply
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and where it intersects our real gdp
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axis this is our full employment output
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if you want to put some numbers on it
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maybe this is equal to for a small
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economy maybe this is equal to 50
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billion dollars
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so the way we've just described this
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we are at equilibrium right now we're at
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full employment output our economy is
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producing 50 billion dollars per year
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and our full employment output implies
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an unemployment rate of four percent
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where we have one percent inflation
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now let's say that there's some type of
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a demand shock let's say all of a sudden
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the government wants to stimulate the
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economy even beyond where it is here and
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so you have a and so they start spending
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all of this money and so you have a
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shift in the aggregate demand curve so
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it would shift to the right so the
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aggregate demand curve would now look
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something like this let's call that
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aggregate demand 2.
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well what happens now and we've seen
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this in previous videos
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now you have we go from this equilibrium
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point which was at this full employment
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output and at this price level let's
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call that
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price level one
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and now we're at this equilibrium point
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people are demanding more so suppliers
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say hey if you want me to produce more
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i'm going to charge you some more for it
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too so our price level has gone up we
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are at price
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level 2
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and we are producing above full
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employment output maybe this level right
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here is 60 billion well how would that
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be reflected on our phillips curves
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well in the short run our economy has
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gotten a little bit above potential so
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in the short run so we would sit on the
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short run phillips curve and our
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unemployment rate would go down but if
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we assume the phillips curve the short
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run phillips curve model that means our
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inflation would go up
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so this point right over here might
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correspond maybe to
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this point
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right over there
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where when we get to that beyond full
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employment output let's say that this is
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60 billion
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right over here
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well maybe our unemployment rate is 2
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and our inflation rate here
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is three percent
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now what happens next well we've talked
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about this when we studied aggregate
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demand and aggregate supply
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workers when it's time for them to
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renegotiate their contracts will say hey
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prices have gone up i'm not going
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willing to work for the same amounts
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over the long run and so you have a
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shift to the left of the aggregate
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supply curve at any given price level
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there's going to be less supply less
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output and so if this shifts to the left
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eventually
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the equilibrium point will go back to
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where everything intersects with the
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long run aggregate supply curve
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so the short run aggregate supply curve
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shifts over there and then we would be
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back to our full employment output
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although our price level would have gone
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even higher price level three now many
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economists would argue that when you
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have a shift in the short run aggregate
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supply so this would be short run
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aggregate supply 2
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that that also is associated with a
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shift in our short run phillips curve
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because of these price increases and
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because workers have are trying to
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renegotiate their salaries upwards and
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labor is the biggest factor in price
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levels you might have increased
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inflation expectations so in a given
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rate of inflation you would you might
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start having a higher unemployment and
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so this short run phillips curve could
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shift to the right so instead of this
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just gravitating back to where it was
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before the whole curve could shift to
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the right and we get to a situation
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that looks like this
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where our inflation is still at three
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percent but we are back to
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the long run unemployment rate of this
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economy
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