Long Run Phillips Curve: Videos & Practice Problems

The long-run Phillips curve illustrates the relationship between unemployment and inflation when the economy operates at potential GDP. At this point, the unemployment rate stabilizes at the natural rate, approximately 4%, despite fluctuations in inflation. This means that regardless of the inflation rate, unemployment remains constant at the natural rate in the long run. The long-run aggregate supply curve is vertical, indicating that inflation can vary while maintaining a steady unemployment rate, emphasizing the distinction from the short-run Phillips curve.

Long Run Phillips Curve

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 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. Whereas 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 fields, 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. And this is what we call our natural rate of unemployment. It's the unemployment rate when the economy is at potential GDP. Okay? So notice, even when we're at our potential GDP, there's still going to 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 going to say that you can pretty much treat these the same, okay? I'm giving you the definitions here, the technical definitions of the difference between the natural rate of unemployment and what we call N.I.R.U, 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 at this level of unemployment, inflation will stay stable. Okay? Now just treat those as the same, 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 going to look a little different than what we had in the short run, in our other video. Okay? So let's go down to the long-run Phillips curve and let's start here in our ADAS model. So remember our ADAS model, we had our price level and we had GDP over here, okay? So we could have different situations for our aggregate demand. But in the long run, we're always going to have this vertical, supply curve. Long-run aggregate supply, right? This is what we learned when we learned the ADAS model. The long-run aggregate supply is going to be straight up and down at our potential GDP. And remember that at our potential GDP, we still have unemployment. But it's that natural rate of unemployment. Natural rate of unemployment which tends to be around 4%. We're going to say it's around 4% for our cases. Okay? So notice what's happening here. We've got we're at this potential GDP, this long-run aggregate supply. And regardless if aggregate demand is down here or up here, well, 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? Regardless of what price level we're at, we're still going to 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 going to have a steady rate of unemployment at that natural rate, but the inflation rate 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% in 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 going to end up at this 4%, 4% unemployment in the natural long run at our natural rate of unemployment. So we end up with a long-run Phillips Curve that goes straight up and down like this. Long-run Phillips Curve basically tells us that at any level of inflation, we're going to have this natural rate of unemployment in the long run, okay? So regardless of the price level, in the long run, we are going to be at this level of unemployment, our 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 unemployment is basically fixed at our natural rate of unemployment when we are at potential GDP, cool? Alright, let's go ahead and move on to the next video.

Here’s what students ask on this topic:

What is the long-run Phillips curve?

The long-run Phillips curve illustrates the relationship between unemployment and inflation when the economy operates at potential GDP. Unlike the short-run Phillips curve, which shows a trade-off between inflation and unemployment, the long-run Phillips curve is vertical. This vertical line indicates that the unemployment rate stabilizes at the natural rate, approximately 4%, regardless of the inflation rate. This means that in the long run, inflation can vary, but the unemployment rate remains constant at the natural rate. This concept emphasizes that monetary policy cannot permanently reduce unemployment below this natural rate without causing accelerating inflation.

Why is the long-run Phillips curve vertical?

The long-run Phillips curve is vertical because it represents a situation where the economy is at its potential GDP, and the unemployment rate is at its natural rate. At this point, all resources are used efficiently, and any unemployment is due to frictional and structural factors, not cyclical ones. This vertical nature indicates that in the long run, there is no trade-off between inflation and unemployment. Regardless of the inflation rate, the unemployment rate remains fixed at the natural rate. This reflects the idea that attempts to reduce unemployment below the natural rate will only lead to higher inflation without affecting long-term unemployment.

What is the natural rate of unemployment?

The natural rate of unemployment is the level of unemployment that exists when the economy is at potential GDP. It includes frictional and structural unemployment but excludes cyclical unemployment. Frictional unemployment occurs when people are temporarily between jobs or entering the workforce, while structural unemployment arises from mismatches between workers' skills and job requirements. The natural rate is considered to be around 4% in many economies. At this rate, inflation is stable, meaning it has no tendency to increase or decrease. This concept is crucial for understanding the long-run Phillips curve, which shows that unemployment remains at this natural rate regardless of inflation levels.

How does the long-run Phillips curve differ from the short-run Phillips curve?

The long-run Phillips curve differs from the short-run Phillips curve in its representation of the relationship between unemployment and inflation. The short-run Phillips curve shows a negative relationship, indicating a trade-off between inflation and unemployment. In the short run, lower unemployment can be achieved at the cost of higher inflation and vice versa. However, the long-run Phillips curve is vertical, indicating that in the long run, the unemployment rate is fixed at the natural rate, regardless of the inflation rate. This distinction highlights that while monetary policy can influence unemployment and inflation in the short run, it cannot permanently reduce unemployment below the natural rate without causing accelerating inflation.

What are the implications of the long-run Phillips curve for monetary policy?

The long-run Phillips curve has significant implications for monetary policy. It suggests that in the long run, monetary policy cannot reduce unemployment below the natural rate without causing accelerating inflation. This means that while central banks can influence inflation and unemployment in the short run, their ability to affect long-term unemployment is limited. Policymakers should focus on maintaining stable inflation rather than trying to reduce unemployment below its natural rate. Attempts to do so will only lead to higher inflation without achieving a permanent reduction in unemployment. This understanding helps guide central banks in setting appropriate monetary policies to ensure long-term economic stability.