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3.3 · HL ONLY · 12 MIN

What Do Phillips Curves Show?

Macroeconomic objectives

What you will learn

  • The short-run Phillips curve describes a conditional inflation–unemployment trade-off.
  • Show expectations adjustment and shifts of Phillips curves

Essential definitions

Short-run Phillips curve
A relationship between inflation and unemployment conditional on expected inflation and supply conditions.
Long-run Phillips curve
A vertical relationship at the natural rate when expectations adjust in the expectations-augmented model.

Read the axes and the short-run relationship

Put the inflation rate, percent per period, on the vertical axis and the unemployment rate, percent of the labour force, horizontally. Unlike AD–AS, this diagram shows an inflation rate rather than a price level. A short-run Phillips curve slopes down for given expected inflation and supply conditions.

Stronger demand encourages firms to produce and hire more, reducing cyclical unemployment. As spare capacity falls, wage and price pressure grows. This gives a movement along the short-run curve. It does not establish that any possible fall in unemployment must raise inflation: better matching or productivity involves a different mechanism.

Follow expectations over time

Suppose unemployment starts at its natural rate of 5% with inflation of 2%. Demand expansion temporarily lowers unemployment to 4% while inflation rises to 4%. If people come to expect 4% inflation, workers seek higher money wages and firms adjust prices. At each unemployment rate, inflation is now higher, shifting the short-run curve upwards.

Unemployment returns towards 5% as expectations adjust, while inflation can remain at 4%. The long-run Phillips curve is vertical at the natural rate. Permanently holding unemployment below it would require repeated inflation surprises in this model, rather than a stable bargain of slightly more inflation for permanently more jobs.

Distinguish structural changes and supply shocks

Better skills, information and mobility can reduce the natural rate and move the long-run curve left. An adverse supply shock instead raises costs, allowing inflation and unemployment to rise together. On AD–AS this is a leftward SRAS shift; on the Phillips diagram it shifts the short-run relationship upwards or outwards.

Observed data therefore need not trace one stable downward curve. Credible policy can influence expectations, but reducing established inflation may still cost output and employment in the short run. Evaluate the shock, expectations and uncertainty about the natural rate before predicting either a painless disinflation or an unavoidable permanent trade-off.

WORKED EXAMPLE

Hypothetical expectations adjustment

  1. The economy initially has unemployment of 5% and inflation of 2%.
  2. A demand expansion temporarily reduces unemployment to 4% and increases inflation to 4%.
  3. After expectations adjust, unemployment returns to the unchanged natural rate of 5%.

The long-run point has unemployment of 5% with higher inflation; it is not a permanent 4%-unemployment equilibrium.

HL ONLY

Short- and long-run Phillips curves

Short- and long-run Phillips curvesWith inflation expectations initially fixed, stronger AD can reduce cyclical unemployment while inflation rises: movement along SRPC₁. When expectations catch up, SRPC shifts up and unemployment returns to the natural rate on LRPC. Initially π = 7 − u. A demand increase moves to B (u=3%, π=4%). When expected inflation rises by 2 points, SRPC shifts up and C returns to uₙ=5%.Inflation rate (%)Unemployment rate (%)01010LRPC (uₙ=5)SRPC₁SRPC₂A52B: short run34C: long run54

Initially π = 7 − u. A demand increase moves to B (u=3%, π=4%). When expected inflation rises by 2 points, SRPC shifts up and C returns to uₙ=5%.

With inflation expectations initially fixed, stronger AD can reduce cyclical unemployment while inflation rises: movement along SRPC₁. When expectations catch up, SRPC shifts up and unemployment returns to the natural rate on LRPC.

How to draw it and model assumptions
  1. Inflation rate (%) vertically and unemployment rate (%) horizontally.
  2. Draw downward SRPC₁ and vertical LRPC at un.
  3. Label short-run B and long-run C on SRPC₂ and LRPC.

Expectations-augmented model; natural unemployment fixed at 5%. Supply shocks can shift SRPC. There is no stable long-run inflation/unemployment trade-off.

Open this diagram with related practice →
SL & HL

Demand management: fiscal and monetary policy

Demand management: fiscal and monetary policyExpansionary monetary or fiscal policy raises spending and AD; contractionary policy lowers it. Closing a recessionary gap can raise output and employment, while closing an inflationary gap restrains price pressure. AD: P = 180 − 0.8Y. SRAS: P = 20 + 0.8Y. E2: Y=100, P=100. The final equilibrium closes the initial gap at Yp=100.Price level (index)Real GDP (index)0200200AD₂AD₁SRASLRASE181.2585E2100100

AD: P = 180 − 0.8Y. SRAS: P = 20 + 0.8Y. E2: Y=100, P=100. The final equilibrium closes the initial gap at Yp=100.

Expansionary monetary or fiscal policy raises spending and AD; contractionary policy lowers it. Closing a recessionary gap can raise output and employment, while closing an inflationary gap restrains price pressure.

How to draw it and model assumptions
  1. Select the initial recessionary or inflationary position.
  2. Shift AD toward the intersection of SRAS and LRAS.
  3. Mark initial E1 and final E2; compare the price level and real output at these intersections.

Short-run upward SRAS; potential output fixed. Policy transmission, confidence, import leakages and time lags determine the size of the actual AD shift.

Explore the existing simulator →
Open this diagram with related practice →

Apply and evaluate

  • Supply shocks can shift the short-run relationship, so a fixed curve is an incomplete empirical prediction.
  • The natural rate is uncertain and can change with institutions, demographics and matching efficiency.

Common misconceptions

  • The Phillips vertical axis is inflation rate, not price level.
  • A vertical long-run curve does not imply zero short-run employment effects from policy.

Knowledge check

What happens to the short-run Phillips curve when expected inflation rises?

Real-world application

An inflation rate is a change, not a price level

16 November 2022: The UK CPI rose 11.1% over the twelve months to October 2022, compared with 10.1% over the twelve months to September.

These are rates over overlapping twelve-month windows. A subsequent fall in the inflation rate would mean slower average price increases, not necessarily falling prices. Judge the costs alongside wages, household expenditure patterns and employment conditions.

ONS, Consumer price inflation, UK: October 2022 ↗

Historical evidence checked 9 October 2026. The model interpretation is an original teaching application.

What to remember

The short-run Phillips curve describes a conditional inflation–unemployment trade-off. Expectations and supply shocks can move it; demand alone cannot permanently hold unemployment below its natural rate.

3 matching questions →3 matching flashcards →Related diagrams →

Completion is your own reflection on learning, not a test score. Syllabus references: 3.3.21.

Lessons in this section
  1. What Are Macroeconomic Objectives?
  2. What Is Economic Growth?
  3. How Does Growth Affect Living Standards?
  4. How Is Unemployment Measured?
  5. Why Are People Unemployed?
  6. What Do Inflation and the CPI Measure?
  7. What Causes Inflation?
  8. Why Can Falling Prices Be a Problem?
  9. How Is a Weighted Price Index Calculated? · HL
  10. How Can We Assess Government Debt? · HL
  11. What Do Phillips Curves Show? · HL

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