THE PHILLIPS CURVE

Original SR Phillips Curve
Inflation and unemployment	Inverse relationship.
Inflation	It increases as the economy expands.
Recession	Unemployment increases as the economy slows down.
Along the curve	Cyclical change in the GDP.
Stagflation
Late 1970s to 1981	Increasing inflation and unemployment at the same time.
Data?
A New Philips Approach
New range?	The SRPC can move inward and outward.
Cost push inflation	More stress on resources, wages and input costs.
Supply shocks	Rapid loss of resources or rapid increase in resource cost.
SRPC curves moves	Outward during shocks.
SRPC moves back	Inward as the society increases productivity or regains resource.
Long Run Philips Curve
Inflation	Society adjusts for cost/wage increases with new prices.
LRPC is?	The efficient PPF.
Natural rate of unemployment	Becomes the equivalent of full employment rate.
Phillips and AD/AS curves
Change points on SRPC	If AD changes, you move the points on the curve.
Move the SRPC	You shift the curve of the SRPC.

THE LONG RUN PHILLIPS CURVE

-Because the long run Phillips curve exists at a natural rate of unemployment (Un), structural changes in the economy that affects Un will cause the LRPC to shift.

-Increases in Un will shift LRPC ->.

-Decreases in Un will shift LRPC <- (Low inflation -> high unemployment).

Relating Phillips curve to AS/AD

-Changes in the AS/AD model can also be seen in the Philips curve.

Misery index

-a combination of inflation and unemployment in any given year. Single digit misery is good.

Supply shocks

-this is the rapid and significant increase in resource cost.

Disinflation

-this is reduction in inflation from year to year or over time. It is found in the LRPC.

Deflation

-general decline in price.

SUPPLY SIDE ECONOMY

-changes in AS and not AD are the main active force in determining the level of inflation, unemployment rates and economy growth.

Supply side economists

-supports policies that promote GDP growth by arguing that high marginal tax rates along with the current system of transfer payment such as unemployment compensation or welfare programs provide disincentive to work , invest, innovate and undertake entrepreneurial ventures.

INCENTIVES TO SAVE AND INVEST

1)      High marginal taxes reduce the revenues for savings and investments.

2)      Consumption might increase but investments depend upon savings.

3)      Lower marginal tax rates encourage savings and investments.

LAFFER CURVE

-theoretical relationship between tax rates and tax revenues. As tax rates increase from zero, tax revenues increase from zero to some maximum level and then decline.

CRITICISM TO THE LAFFER CURVE

1)      Evidence suggests that the impact of tax rates on incentives to work, save and invest is small.

2)      Tax cuts increase demand which can fuel inflation and demand may exceed supply.