Explain how the short-run Phillips curve, the long-run Phillips curve, the short-run aggregate supply curve, the long-run aggregate supply curve, and the natural rate hypothesis are all related. ...

Explain how the short-run Phillips curve, the long-run Phillips curve, the short-run aggregate supply curve, the long-run aggregate supply curve, and the natural rate hypothesis are all related.  How do active and passive views of these concepts differ?

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pohnpei397 | College Teacher | (Level 3) Distinguished Educator

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The short run aggregate supply curve (SRAS) and the short term Phillips curve both show essentially the same thing happening.  The long run aggregate supply curve (LRAS) and the long term Phillips curve are also identical.  The fact that the two long run curves are identical (both are vertical) is connected to the idea that there is a natural rate of unemployment.

The short term Phillips curve tells us that unemployment and inflation rates are inversely related.  When inflation is high, unemployment is low.  When inflation is low, unemployment is high.  The curve slopes downward to the right.  This is true because low unemployment tends to lead to higher wages and higher prices.  The SRAS tells us that GDP rises as price level rises (as inflation occurs).  This is similar to what is going on in the short term Phillips curve because a drop in unemployment (which comes along with an increase in inflation) will cause GDP to rise as more people get jobs and produce goods and services.  Thus, the curve of the SRAS and the curve the short term Phillips curve are both caused by similar phenomena.

The long term Phillips curve tells us that, in the long run, there is no connection between unemployment and inflation.  In the long run, there is a single rate of unemployment that will occur at any rate of inflation.  This is because the economy will adjust to any price level and will automatically self-correct to achieve full employment at that level.  This same phenomenon is shown in the LRAS.  The LRAS, like the long term Phillips curve, is vertical.  They both show that, in the long term, price level has no impact on economic growth (which is, itself, connected to unemployment rates).

This idea is connected to the idea of the natural rate of unemployment.   There will always be some unemployment because there will always be people who are looking for their first job or who have quite one job to look for another they like better (frictional unemployment).  There will always be some unemployment as people’s jobs become obsolete due to mechanization, globalization, or changing tastes (structural unemployment).  Because of this, there will always be some unemployment no matter how much or how little inflation there is.  In the long run, this will help to ensure that both the long term Phillips curve and the LRAS are vertical even though the short run Phillips curve and the SRAS are not.

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