U5.2 The Phillips Curve
Master the AP Macro Phillips Curve: build the downward-sloping SRPC and vertical LRPC at NAIRU, and link every shift to AD-AS dynamics.
What you'll do in this lesson
A voice-first session with the Crimsora tutor on U5.2 The Phillips Curve, then targeted practice and FRQs — with the tutor adapting to where you get stuck.
What this lesson covers
The Phillips Curve is the AD-AS model told from a different angle — instead of plotting real GDP against the price level, it plots inflation against unemployment. If you already understand how aggregate demand and aggregate supply shift, this topic becomes a translation exercise rather than something brand new.
In this lesson you will construct both the short-run Phillips Curve (SRPC) and the long-run Phillips Curve (LRPC), see why inflation expectations shift the SRPC, and connect every Phillips Curve movement to a matching shift in the AD-AS graph. Getting this connection right is exactly what AP free-response questions reward.
In this lesson you will construct both the short-run Phillips Curve (SRPC) and the long-run Phillips Curve (LRPC), see why inflation expectations shift the SRPC, and connect every Phillips Curve movement to a matching shift in the AD-AS graph. Getting this connection right is exactly what AP free-response questions reward.
The Short-Run Trade-Off
The short-run Phillips Curve shows an inverse relationship between the inflation rate (vertical axis) and the unemployment rate (horizontal axis). When inflation is high, unemployment tends to be low; when inflation is low, unemployment tends to be high. This trade-off exists only in the short run.
The logic comes straight from the AD-AS model. Suppose aggregate demand rises. Real GDP increases, which lowers cyclical unemployment, and the price level rises, which means inflation goes up. So a rightward AD shift produces lower unemployment plus higher inflation — a single movement up and to the left along a fixed SRPC.
The key exam skill is recognizing that a movement ALONG the SRPC corresponds to a shift IN aggregate demand. Students often confuse a movement along the curve with a shift of the curve — the AP graders watch for this distinction carefully.
The logic comes straight from the AD-AS model. Suppose aggregate demand rises. Real GDP increases, which lowers cyclical unemployment, and the price level rises, which means inflation goes up. So a rightward AD shift produces lower unemployment plus higher inflation — a single movement up and to the left along a fixed SRPC.
| AD-AS event | Movement on Phillips Curve |
|---|---|
| AD increases | Move up-left along SRPC (inflation up, unemployment down) |
| AD decreases | Move down-right along SRPC (inflation down, unemployment up) |
The Long-Run Phillips Curve and NAIRU
The long-run Phillips Curve is a vertical line at the natural rate of unemployment, also called NAIRU (the Non-Accelerating Inflation Rate of Unemployment). It is vertical because in the long run there is no trade-off between inflation and unemployment: the economy returns to its natural rate of unemployment regardless of the inflation rate.
This mirrors the vertical long-run aggregate supply (LRAS) curve, which sits at full-employment output . The LRPC and LRAS describe the same idea from two perspectives — the economy's productive capacity does not depend on the price level or inflation rate.
The natural rate of unemployment includes frictional and structural unemployment but excludes cyclical unemployment. When the economy operates at NAIRU, cyclical unemployment is zero. Points to the left of the LRPC represent an inflationary gap (unemployment below natural rate); points to the right represent a recessionary gap (unemployment above natural rate).
A common misconception is that the LRPC being vertical means unemployment never changes. It changes in the short run as the economy moves along the SRPC, but it always gravitates back to NAIRU in the long run. Only changes to the underlying labor market — for example, better job-matching technology — can shift the LRPC itself.
This mirrors the vertical long-run aggregate supply (LRAS) curve, which sits at full-employment output . The LRPC and LRAS describe the same idea from two perspectives — the economy's productive capacity does not depend on the price level or inflation rate.
The natural rate of unemployment includes frictional and structural unemployment but excludes cyclical unemployment. When the economy operates at NAIRU, cyclical unemployment is zero. Points to the left of the LRPC represent an inflationary gap (unemployment below natural rate); points to the right represent a recessionary gap (unemployment above natural rate).
A common misconception is that the LRPC being vertical means unemployment never changes. It changes in the short run as the economy moves along the SRPC, but it always gravitates back to NAIRU in the long run. Only changes to the underlying labor market — for example, better job-matching technology — can shift the LRPC itself.
Inflation Expectations Shift the SRPC
The single most tested concept in this topic is that changes in expected inflation shift the entire short-run Phillips Curve. If workers and firms expect higher inflation, they build those expectations into wage and price contracts, so the SRPC shifts upward (higher inflation at every unemployment rate). If they expect lower inflation, the SRPC shifts downward.
Supply shocks shift the SRPC too. A negative supply shock (say, an oil price spike) raises both inflation and unemployment — stagflation — shifting the SRPC up and right. This matches a leftward shift of short-run aggregate supply (SRAS). A positive supply shock shifts the SRPC down and left, matching a rightward SRAS shift.
Notice that the SRPC intersects the LRPC exactly at the expected inflation rate. When actual inflation equals expected inflation, unemployment equals NAIRU — this is the self-correction endpoint.
Supply shocks shift the SRPC too. A negative supply shock (say, an oil price spike) raises both inflation and unemployment — stagflation — shifting the SRPC up and right. This matches a leftward shift of short-run aggregate supply (SRAS). A positive supply shock shifts the SRPC down and left, matching a rightward SRAS shift.
| Cause | SRPC shift | AD-AS equivalent |
|---|---|---|
| Expected inflation rises | Up/right | (built into SRAS via wages) |
| Expected inflation falls | Down/left | — |
| Negative supply shock | Up/right | SRAS left |
| Positive supply shock | Down/left | SRAS right |
Putting It Together: Self-Correction
The Phillips Curve and AD-AS models must tell a consistent story. Consider an economy pushed into an inflationary gap by a surge in aggregate demand. On the AD-AS graph, AD shifts right, output exceeds , and unemployment falls below NAIRU. On the Phillips Curve, the economy moves up and left along the SRPC to a point to the left of the LRPC.
This situation is not sustainable. Low unemployment pushes up wages, and workers revise their inflation expectations upward. Higher expected inflation shifts SRAS left (AD-AS) and shifts the SRPC upward (Phillips). The economy slides back to NAIRU, but now at a higher inflation rate. The long-run result: unemployment returns to the natural rate, and only the inflation rate is permanently higher.
This is why the LRPC is vertical — attempts to keep unemployment below NAIRU using demand-side policy only ratchet up inflation over time without any lasting employment gain. On the AP exam, you may be asked to show this two-step process on both graphs and explain the role of adjusting expectations. Always identify the initial short-run point, the direction of the shift, and the final long-run point on the LRPC.
This situation is not sustainable. Low unemployment pushes up wages, and workers revise their inflation expectations upward. Higher expected inflation shifts SRAS left (AD-AS) and shifts the SRPC upward (Phillips). The economy slides back to NAIRU, but now at a higher inflation rate. The long-run result: unemployment returns to the natural rate, and only the inflation rate is permanently higher.
This is why the LRPC is vertical — attempts to keep unemployment below NAIRU using demand-side policy only ratchet up inflation over time without any lasting employment gain. On the AP exam, you may be asked to show this two-step process on both graphs and explain the role of adjusting expectations. Always identify the initial short-run point, the direction of the shift, and the final long-run point on the LRPC.
Key terms
- Short-Run Phillips Curve (SRPC).
- A downward-sloping curve showing the inverse short-run relationship between the inflation rate and the unemployment rate at a given expected inflation rate.
- Long-Run Phillips Curve (LRPC).
- A vertical line at the natural rate of unemployment, showing no long-run trade-off between inflation and unemployment.
- NAIRU / Natural Rate of Unemployment.
- The unemployment rate consistent with stable inflation, equal to frictional plus structural unemployment, with zero cyclical unemployment.
- Inflation Expectations.
- The inflation rate that workers and firms anticipate; changes in expected inflation shift the entire SRPC up or down.
- Supply Shock.
- A sudden change in production costs or resource availability that shifts both SRAS and the SRPC; a negative shock causes stagflation.
- Stagflation.
- The simultaneous occurrence of rising inflation and rising unemployment, shown as an upward-right shift of the SRPC.
- Inflationary Gap.
- A short-run condition where output exceeds full employment and unemployment is below NAIRU, shown left of the LRPC.
Worked example
An economy is initially in long-run equilibrium at 5% unemployment and 2% inflation. The central bank sharply increases the money supply, boosting aggregate demand. Describe the short-run and long-run effects on the Phillips Curve.
Start at the long-run equilibrium: unemployment equals NAIRU at 5%, and this point lies on both the SRPC and the vertical LRPC, with inflation at 2%. Because the economy sits on the LRPC, expected inflation equals actual inflation at 2%.
Step one, the short run. The money supply increase raises aggregate demand, so real GDP rises above and cyclical unemployment falls, say to 3%. Higher demand pushes the price level up, so inflation rises, say to 4%. On the Phillips Curve the economy moves up and to the left ALONG the existing SRPC — from (5%, 2%) to (3%, 4%). This is a movement along the curve, not a shift, and it corresponds to a rightward shift of AD in the AD-AS model. The economy now sits to the left of the LRPC in an inflationary gap.
Step two, the long run. With unemployment below NAIRU, tight labor markets raise wages and workers revise inflation expectations upward from 2% toward 4%. Rising expected inflation shifts the SRPC upward and shifts SRAS leftward. Output falls back to and unemployment returns to 5%. The new long-run point sits back on the vertical LRPC but at the higher inflation rate of about 4%.
Conclusion: expansionary policy lowered unemployment only temporarily. In the long run unemployment returns to NAIRU while inflation is permanently higher — the vertical LRPC in action.
Step one, the short run. The money supply increase raises aggregate demand, so real GDP rises above and cyclical unemployment falls, say to 3%. Higher demand pushes the price level up, so inflation rises, say to 4%. On the Phillips Curve the economy moves up and to the left ALONG the existing SRPC — from (5%, 2%) to (3%, 4%). This is a movement along the curve, not a shift, and it corresponds to a rightward shift of AD in the AD-AS model. The economy now sits to the left of the LRPC in an inflationary gap.
Step two, the long run. With unemployment below NAIRU, tight labor markets raise wages and workers revise inflation expectations upward from 2% toward 4%. Rising expected inflation shifts the SRPC upward and shifts SRAS leftward. Output falls back to and unemployment returns to 5%. The new long-run point sits back on the vertical LRPC but at the higher inflation rate of about 4%.
Conclusion: expansionary policy lowered unemployment only temporarily. In the long run unemployment returns to NAIRU while inflation is permanently higher — the vertical LRPC in action.
Practice questions
An increase in workers' expected inflation will most likely cause which of the following?
- A movement down and to the right along the short-run Phillips Curve
- An upward shift of the short-run Phillips Curve
- A rightward shift of the long-run Phillips Curve
- A movement along the long-run Phillips Curve
Answer: An upward shift of the short-run Phillips Curve
Expected inflation is what pins the position of the SRPC. When people expect more inflation, they build it into wages and prices, so at every unemployment rate the inflation rate is higher — the whole SRPC shifts up. It is not a movement along the curve (that comes from AD changes), and the LRPC only shifts if the natural rate of unemployment itself changes.
A negative supply shock, such as a sharp rise in oil prices, hits the economy. Explain what happens to the short-run Phillips Curve and to unemployment and inflation, and identify the corresponding AD-AS shift.
Answer: The SRPC shifts up and to the right, causing higher inflation and higher unemployment simultaneously (stagflation); this corresponds to a leftward shift of SRAS.
A negative supply shock raises production costs across the economy. In AD-AS terms SRAS shifts left, which raises the price level (higher inflation) and lowers real GDP (higher cyclical unemployment). On the Phillips Curve this cannot be a movement along a single curve because both inflation and unemployment rise together, so the entire SRPC must shift up and to the right. This dual worsening is the definition of stagflation.
The long-run Phillips Curve is vertical at 4% unemployment. If actual unemployment is currently 6%, is the economy in an inflationary or recessionary gap, and what will happen over time?
Answer: Recessionary gap; over time inflation expectations fall, the SRPC shifts down, and unemployment returns to 4%.
Unemployment of 6% is above the natural rate of 4%, meaning positive cyclical unemployment and output below full employment — a recessionary gap, shown to the right of the LRPC. High unemployment puts downward pressure on wages and lowers inflation expectations. This shifts the SRPC downward (and SRAS rightward in AD-AS), moving the economy back to 4% unemployment on the LRPC at a lower inflation rate.
FAQ
- Why is the long-run Phillips Curve vertical?
- Because in the long run there is no trade-off between inflation and unemployment. Once inflation expectations fully adjust, the economy returns to its natural rate of unemployment (NAIRU) no matter what the inflation rate is. This mirrors the vertical LRAS curve at full-employment output.
- What is the difference between a movement along the SRPC and a shift of the SRPC?
- A movement along the SRPC comes from a change in aggregate demand — it trades inflation for unemployment. A shift of the SRPC comes from a change in inflation expectations or a supply shock. Confusing the two is one of the most common AP mistakes.
- How does the Phillips Curve connect to the AD-AS model?
- They describe the same economy. A rightward AD shift is a move up-left along the SRPC. A leftward SRAS shift (or higher expected inflation) shifts the SRPC up. The LRPC corresponds to the vertical LRAS, both located at full employment.
- What causes the short-run Phillips Curve to shift?
- Two main things: changes in expected inflation and supply shocks. Higher expected inflation or a negative supply shock shifts the SRPC up and right; lower expected inflation or a positive supply shock shifts it down and left.
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