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Learn the toughest concepts covered in your Macroeconomics class with step-by-step video tutorials and practice problems.

Revisiting Inflation, Unemployment, and Policy

Long Run Phillips Curve


Long Run Phillips Curve

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Alright, so now that we've seen the short run phillips curve, let's go ahead and move into the long run phillips curve. So remember that the phillips curve is showing us this relationship between unemployment and inflation. Okay, so in the long run we're going to see something a little different than what we saw in the short run, recall that in the long run we're talking about a situation where the where the economy is functioning at potential GDP. Okay, so all resources are used, right? We're using all our resources efficiently and effectively in the long run um Where in the short run there could be some sort of fluctuations based on short run conditions. Okay, so all our resources are being used. That doesn't mean that everybody in the economy is employed, that means we've reached what's called our natural rate of unemployment, remember at any point in time people are going to be unemployed because they're switching jobs, they're switching feet, they got laid off and they're looking for a new job, right? There could be some sort of frictional unemployment, right? Something going on a structural unemployment as they look for new jobs. Um and this is what we call our natural rate of unemployment, it's the unemployment rate when the economy is at potential oops, potential GDP. Okay, so notice even when we're at our potential GDP there's still gonna be some unemployment in the economy, there's just no way to avoid having some unemployment. Okay and we also talk about this other unemployment rate in this class, I'm gonna say that you can pretty much treat these the same. Okay. I'm giving you the the definitions here, the technical definitions of the difference between natural rate of unemployment and what we call Nairu and Ai are you which is our non accelerating inflation rate of unemployment now it's a little bit more complicated but for our purposes we can treat them pretty much the same. So it's the unemployment rate at which where inflation has no tendency to increase or decrease. Okay so we can at this level of unemployment inflation will stay stable. Okay now just treat those as the same um in this class you just have the definitions there. Okay. So what we've been seeing is when aggregate demand increases, we saw how it affected the price level and unemployment in the short run before we fill that in. Let's go down to the graphs and let's see what our long run phillips curve looks like and then we'll go back up there and we'll fill these out for the long run. So I'm gonna put here for the long run because it's gonna look a little different than what we had in the short run um in in our other video. Okay so let's go down to the long run phillips curve and let's start here in R. A. D. A. S. Model. So remember R. A. D. A. S. Model. We had our price level and we had G. D. P. Over here. Okay so we could have different situations for for our aggregate demand but in the long run we're always gonna be we're gonna have this vertical supply curve. Long run aggregate supply, right? This is what we learned when we learned the A. D. A. S. Model. The long run aggregate supply is gonna be straight up and down at our potential GDP. And remember that at our potential GDP we still have unemployment. Um But it's it's that natural rate of unemployment. Natural natural rate of unemployment Which tends to be around 4%. We're gonna say it's around 4% for our cases. Okay? Um so notice what's happening here. We've got we're at this potential GDP this long run aggregate supply And regardless of aggregate demand is down here or up here while our long run equilibrium is going to be at this potential GDP of 4%. However look at what can happen in our price level, we could be at this lower price level say 102 or at this higher price level say 106. Right? Um Regardless of what what price level we're at, we're still gonna have that 4% unemployment right? That natural rate of unemployment in the long run. Okay. So this is what happens in the long run in the phillips curve is that we see that we're gonna have a steady rate of unemployment at that natural rate but the inflation rate uh can actually fluctuate. So our long run phillips curve looks a little different than our short run phillips curve. So this is our inflation rate on this axis, unemployment rate on this axis. And what do we see here? So if we say this is our 4% unemployment rate, well regardless of what the price level, is maybe we have 2% inflation right here Or we have 6% inflation over here but we're still gonna end up at this 4% um 4% unemployment in the natural, in the long run, at our natural rate of unemployment. So we end up with the long run phillips curve that goes straight up and down like this long run phillips curve basically tells us that at any level any level of inflation we're gonna have this natural rate of unemployment in the long run. Okay, so regardless of the price level in the long run we're going to be at this level of unemployment are natural rate of unemployment. Alright, so we'll see what the implications of the long run and the short run are in future videos But for now just understand that in the long run our our unemployment is basically fixed at our natural rate of unemployment when we are potential GDP Cool. Alright, let's go ahead and move on to the next video