What is the Phillips Curve Economics | Short & Long Run Phillips Curve

The Phillips Curve illustrates how inflation and unemployment relate to each other and is an important topic for economics and university work. In this blog, you’ll find the Phillips Curve explained in clear, simple terms so that you can understand it better and apply it to your coursework. As your assignment helper in the UK, we are here to help you understand this concept.

Introduction

The Phillips Curve is a key concept in macroeconomics, which illustrates the relationship between inflation and unemployment. In general, the Phillips Curve indicates that inflation and unemployment are inversely related: unemployment decreases when inflation increases, and unemployment increases when inflation decreases. This relationship is significant for policymakers and occurs in written assignments and essays and exam questions.

The Origins of the Phillips Curve

To understand Phillips Curve economics, we need to go back to the late 1950s. A.W. Phillips, an economist from New Zealand, investigated the UK data for the period 1861 to 1957. Phillips was interested in the relationship between wages and the level of unemployment.

Phillips identified an inverse relationship that was fairly consistent: at lower levels of unemployment, wages would increase more rapidly, and at higher levels of unemployment, wages would increase more slowly. Phillips' original curve was for wage inflation, but later economists changed the modelling and inverted the curve to consider price inflation, which thus makes it easier for economists to carry out the macroeconomic analysis we examine today.

Learning from the Phillips Curve, specifically associated with UK data, is, of course, more relevant for students of economics studying in the UK context. It allows you to put local policy decisions and think about UK economic trends more holistically in your different coursework.

Understanding the Inflation–Unemployment Trade-off

 

At the core of Phillips Curve economics is an uncomplicated yet potent trade-off: lower unemployment usually comes with a higher rate of inflation. But why?

When more people are at work, there is usually greater purchasing power in the economy. This increase in buying goods and services creates demand-pull inflation because demand is greater than supply. In addition, employers may increase wages to attract workers or to keep employees from taking job offers from other employers, which also puts upward pressure on prices.

This relationship, or trade-off, is the heart of the Phillips Curve theory. Let’s think about an everyday example:

Suppose you are in the United Kingdom and there is a booming job market that has created record-low unemployment. Many companies are actively seeking workers, and they are raising wages to find workers. As people have more income from work, they also, for instance, begin spending their disposable income. Increased spending creates demand for products and services and ultimately pushes prices higher. Welcome to inflation.

This inverse relationship is key to short-run Phillips curve models, and it can help policymakers better understand the types of decisions that result in longer-lasting effects on inflation (and unemployment) in the short run.

Short-Run Phillips Curve vs Long-Run Phillips Curve

Now, let's dive into perhaps one of the most well-known aspects of this theory, the differences between the short-run Phillips curve and the long-run Phillips curve.

In the short run, the curve slopes down, which represents the trade-off we have just discussed. In the short run, wages and prices are "sticky" or do not change as quickly as other variables in the economy. Policymakers may use fiscal or monetary policy to reduce unemployment but accept a little extra inflation along the way.

There are features of the short run that it is important to remember as well:

Sticky Wages: Workers' wages do not go up and down as the economy changes or in real time, meaning inflation can increase faster than changes in wages.

Adaptive Expectations: People have expectations based on experience and do not expect something to change immediately.

Temporary Gains: An increase in demand may cause a reduction in unemployment in the short run but can lead to inflation.

Over the longer run, however, things change. The curve becomes vertical at what economists call the Non-Accelerating Inflation Rate of Unemployment (also known as NAIRU). Here is why: 

1. The inflation expectations adjust: Over time, people expect prices to rise and adjust their wage demands accordingly.

2. There is no longer a trade-off: if you try to force unemployment to be below its natural rate, that can only lead to ever-accelerating inflation.

3. Policy options become less effective: every time you use demand-side policy to boost the economy, you may cause inflation but not keep unemployment below its natural rate.

This long-term perspective is important for students who are completing these assignments about the macroeconomy. It helps you understand why central banks (in this case, the Bank of England) are trying to manage inflation and accept a baseline of unemployment as an 'unfortunate' cost.

Confused about how to explain the short-run and long-run Phillips curves in the assignment? Don’t worry. Locus Assignments can help you with that.

Criticism and Limitations of the Phillips Curve

The Phillips Curve has been widely used and held an important position in macroeconomics; however, it does have challengers. The macroeconomic issue of stagflation during the 1970s in the UK and other Western economies dealt a significant blow to the Phillips Curve. Stagflation is a contraction with high inflation, which the Phillips Curve does not take into account.

Other criticisms include:

Globalisation: Open trade and open international markets for labour can erode the domestic inflation-unemployment relationship.

Supply shocks: Unexpected price shocks for oil, food shortages, or other issues may disrupt logic expressed in the curve.

Technology: Automation and AI will decrease jobs and will not impact inflation in any way.

Expectations theory: Milton Friedman and other economists argue that expectations and inflation play a bigger factor than previously suspected.

Key Takeaways: What You Need to Remember

To briefly summarise the Phillips curve in case you will have to prepare for more studying or assignments:

1. The Phillips curve depicts the inverse correlation between unemployment and inflation.

2. The short-run Phillips curve shows a clear trade-off, which is useful for temporary policy action.

3. In the long run, the Phillips curve trade-off disappears because expectations adjust.

4. The limitations of the Phillips curve are evident from critiques such as stagflation, globalisation and supply-side shocks.

Conclusion 

Economics students need to understand the Phillips Curve in both short-run and long-run implications, particularly when one is studying macroeconomic policy and real examples of the economy. The Phillips Curve can provide valuable insights into the interrelationship between inflation and unemployment, but it has limitations as well.

With this Phillips Curve explained in simple terms, you now have a solid foundation to approach macroeconomic assignments more confidently. And if you ever feel stuck with your assignments, Locus Assignments is here to help you.