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

The Phillips Curve illustrates the relationship between inflation and unemployment and is a crucial topic in economics and university studies. 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, essays and exam questions.

Historically, the Phillips Curve focused on the relationship between wage inflation and unemployment, rather than price inflation. Later, economists modified the theory to examine price inflation, making it more relevant to contemporary macroeconomic theory.

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 increased more rapidly, and at higher levels of unemployment, wages increased 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.

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The Phillips Curve Graph Explained

The Phillips Curve is typically shown in graphical form, which turns out to be very useful for tests and assignments. 

The unemployment rate is shown on the horizontal axis (X-axis), while the inflation rate is shown on the vertical axis (Y-axis). 

In the short term, the graph is a downward-sloping curve that shows the trade-off between unemployment and inflation.  In the long term, the graph is a vertical line at the natural rate of unemployment (NAIRU), which shows that inflation is free to change without affecting unemployment. 

Understanding this graph will allow students to answer questions about the Phillips Curve in graph form.

Short run Phillips Curve vs Long run phillips curve

One of the most interesting aspects of Phillips Curve analysis is the comparison between the short run and long run Phillips curves and how their graphs represent different economic conditions.

short run Phillips Curve

In the short run, wages and prices are sticky, or they don’t change immediately in response to changes in the economy. This stickiness gives policymakers the ability to lower unemployment by using expansionary fiscal or monetary policies, even if it means slightly increasing inflation.

Key Features of the short run Phillips Curve:

1. Sticky wages: Wages don’t change immediately in response to changes in inflation

2. Expectations are adaptive: People make forecasts of inflation based on recent experience

3. Temporary solutions: Unemployment can be temporarily reduced in the short run, but the solution may be only temporary

Long run Phillips curve

In the long run, the graph of the Phillips Curve looks completely different. The Phillips Curve becomes a vertical line at the Non-Accelerating Inflation Rate of Unemployment (NAIRU).

Why Does This Happen?

Inflationary expectations change: Workers expect inflation and demand higher wages

No trade-off: Reducing unemployment below its natural rate simply leads to more inflation in the long run

Policy effectiveness changes: Demand-side policies become less effective in the long run

This concept of the Phillips Curve can be used to explain why central banks, such as the Bank of England, focus on controlling inflation as the central economic policy goal, rather than unemployment.

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The Expectations-Augmented Phillips Curve

Later, economists developed the concept into the expectations-augmented Phillips Curve model. 

In this model, when workers and firms expect inflation to rise, they adjust wages and prices based on that expectation. This implies that the short run Phillips curve may shift upwards and that policymakers may face diminishing returns to expansionary policies. 

The model also raises the possibility that there may be more than one short run Phillips curve. 

This model explains why inflation rises without any corresponding gain in employment and is a standard reference point in advanced economics education.

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:

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

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

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

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

Rather than eliminating inflation effects, technology and automation tend to weaken the traditional Phillips Curve relationship, especially in advanced economies.

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Policy Implications of the Phillips Curve

The Phillips Curve has important implications for economic policy. Central banks use it to assess the degree of inflationary pressure, while governments are aware of the risks of over-encouraging aggregate demand. Inflation targeting is a means of ensuring that the overall economy remains stable. For UK policymakers, the Phillips Curve highlights the importance of keeping inflation under control relative to the creation of jobs.

Does the Phillips Curve Still Apply Today?

The Phillips Curve has become shallower in the past decades, with inflation becoming less responsive to changes in unemployment. This is due to the global supply chain networks, digitalisation, and the changes in policies after the financial crisis.

However, the Phillips Curve is still relevant today, although it is no longer a precise tool for prediction.

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 the Phillips Curve explained in simple terms, you now have a solid foundation to approach macroeconomic assignments more confidently. However, if you need help applying theory to exam questions or coursework, Locus Assignments is here to help. Simply log in to Locus Assignments, order your assignments, or contact us through our website to receive reliable and affordable economics assignment support.

Frequently Asked Question

1. What is the Phillips Curve explained?

The Phillips Curve explains the inverse relationship between inflation and unemployment, showing that lower unemployment is often linked to higher inflation in the short run.

2. How does inflation affect the Phillips Curve?

Rising inflation shifts the short-run Phillips Curve upward as workers demand higher wages, while in the long run, inflation does not reduce unemployment.

3. What are the two types of Phillips Curve?

The two types are the short run Phillips Curve, which shows a trade-off, and the long run Phillips Curve, which shows no trade-off.

4. Does the Phillips Curve still hold true?

It still works as a general framework, but it is less accurate today due to globalisation, technology, and changing inflation expectations.

About Author

Dr Michael Harper is an economics specialist with extensive experience in academic research and higher-education support. His work focuses on economic theory, public policy, and applied economics, with particular attention to simplifying complex concepts for students. At Locus Assignments, he supports learners by providing clear, well-structured academic guidance and subject-specific assistance to help them meet university assessment standards with confidence.