expectations-augmented Phillips curve (short- and long-run Phillips curve)

Short‑Run Phillips Curve

The Phillips curve shows a trade‑off between inflation (\$\pi\$) and unemployment (\$u\$).

In the short run, expectations of future inflation are not fully adjusted, so the curve is

downward sloping.

Equation (short‑run):

\$ \pi = \pi^e - \beta (u - u^n) \$

where:

• \$\pi^e\$ = expected inflation
• \$u^n\$ = natural rate of unemployment
• \$\beta > 0\$ = slope parameter

Analogy: Think of a seesaw. If the left side (inflation) goes up, the right side (unemployment) goes down, but only until the seesaw reaches a new balance point.

Long‑Run Phillips Curve

In the long run, people fully anticipate inflation, so the trade‑off disappears.

The curve becomes vertical at the natural rate of unemployment.

Equation (long‑run):

\$ \pi = \pi^e \$

This means unemployment will always be \$u^n\$, regardless of inflation.

Example: If the government tries to keep unemployment below \$u^n\$ by pushing inflation higher, workers will eventually notice the higher prices and adjust their wage demands, bringing unemployment back to \$u^n\$.

Exam Tips 🎯

1. Draw both curves clearly; label axes and key points.
2. Explain why the short‑run curve is downward sloping and the long‑run is vertical.
3. Use the expectations‑augmented equation to show how a shift in expectations moves the curve.
4. Remember the natural rate of unemployment (\$u^n\$) is the long‑run equilibrium.
5. Include a brief discussion on the policy trade‑offs (e.g., inflation targeting vs. unemployment).