Problems in the Macro Economy
Inflation
and Unemployment
Study Questions
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1. What is the
trade-off inherent in the Phillips Curve?
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2. What causes a
movement upward (downward) on the Phillips Curve?
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3. What events
cause a shift of the Phillips Curve to the left (right)?
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4. What caused
the overheated economy of the late 1960’s?
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5. What events
caused the high unemployment in the Great Depression?
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6. What is a
“supply shock”?
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7. How does a
productivity gain influence the Phillips Curve?
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8. How does a
reduction in tax rates influence the Phillips Curve?
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9. What is the macroeconomic
goal?
Problems
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When the economy is overheated, inflation is the
problem.
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When the economy is under performing,
unemployment is the problem.
The Phillips Curve
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Shows the short-run trade-off between
unemployment and inflation.
¨ unemployment
rate increases? inflation rate falls.
¨ unemployment
rate decreases? inflation rate rises.
The Phillips Curve
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Its position is determined by the capability and
the incentive of the economy to produce.
Figure 11-1. The Phillips Curve
Movement Along the Phillips Curve
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In the short run, assume no change in the
capability or the incentive of the economy to produce.
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Increased total spending causes a movement
upward and to the left on the Phillips Curve.
¨ inflation
rate increases
¨ unemployment
rate decreases
Figure 11-2. Movement Along the Phillips
Curve
Movement Along the Phillips Curve
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In the short run, assume no change in the
capability or the incentive of the economy to produce.
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Decreased total spending causes a movement downward
and to the right on the Phillips Curve.
¨ inflation
rate decreases
¨ unemployment
rate increases
Figure 11-3. Movement Along the Phillips
Curve
Shifting the Phillips Curve
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The Phillips Curve shifts leftward and downward
toward the origin if:
¨ production
costs are lowered
¨ productivity
is increased
¨ the
incentive to work more or harder is increased
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Both the unemployment rate and the inflation
rate will decrease.
Figure 11-4. Shifting the Phillips Curve
Left
Shifting the Phillips Curve
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The Phillips Curve shifts rightward and upward
away from the origin if:
¨ production
costs are increased
¨ productivity
is decreased
¨ the
incentive to work more or harder is decreased
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Both the unemployment rate and the inflation
rate will increase.
Figure 11-5. Shifting the Phillips Curve
Right
Example: The 1960s
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A relatively constant increase in government
spending.
¨ War
on Poverty
¨ War
in Vietnam
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Movement upward and to the left along the Phillips
Curve
¨ inflation
rose rapidly
¨ overheated
economy
Figure 11-6. The 1960’s
Example: The Great Depression
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This was a worldwide economic downturn.
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From 1929 to 1932, total spending decreased.
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Movement
downward and to the right along the Phillips Curve
¨ unemployment
rate rose to 24 percent
¨ negative
inflation – deflation - occured
Figure 11-7. The Great Depression, 1929-1932
Example: 1972-1975
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Supply shock: The price of oil tripled.
¨ Production
costs increased.
¨ Phillips
Curve shifted upward and to the right.
¨ Inflation
rate rose.
¨ Unemployment
rate rose.
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Rising unemployment led to 1975’s decrease in
total spending.
Figure 11-8. 1972-1975
Example: 1976-1982
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Another supply
shock: doubling the price of oil in 1979.
¨ Phillips Curve shifted upward and to the right again.
¨ Higher inflation rates and higher unemployment rates.
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1976-1979:
Movement upward along the Phillips Curve as total spending increased.
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1980-1982:
Movement downward along the Phillips Curve as the Fed campaigned against high
inflation rates.
Figure 11-9. 1976-1982
Example: The 2000s
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Another shock in 2003 (anticipated oil price
rise due to the Middle East war)
¨ Phillips
Curve shifted upward and to the right.
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2000-02: Decreased spending due to recession and
unemployment.
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2003-06: 2003 Bush tax cuts led to increased
total spending and then a leftward shift in the Phillips Curve.
Figure 11-10: The 2000s
Example: The 1980s
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Phillips Curve
shifted downward and to the left in 1983 and 1984-86 due to:
¨ significant innovation
¨ technological advancement
¨ productivity gains
¨ Reagan tax cuts
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Lower inflation
and increased employment caused increased total spending in between the
Phillips Curve shifts
Figure 11-11. The 1980’s
Example: The 1990s
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More technological innovation and productivity
gains shifted Phillips Curve downward and to the left in 1992-94 and 1996-98,
with increased spending in between the shifts.
Figure 11-12. The 1990’s
The Macroeconomic Goal
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Full-employment
¨ operate
on the institutional PPC
¨ zero
cyclical unemployment
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Also called:
¨ the
“Natural Rate” of unemployment
¨ the
“Non-Accelerating Inflation Rate of Unemployment”
Non-Accelerating Inflation Rate of
Unemployment
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The Phillips
Curve changes slope where the trade-off between unemployment and inflation
changes.
¨ On the left, the economy is overheating.
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Inflation rate
rises fast
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Unemployment rate
falls slowly
¨ On the right, the economy is underperforming.
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Inflation rate
rises slowly
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Unemployment rate
falls fast
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The point where
inflation accelerates and begins to rise faster is the full-employment goal.
Figure 11-13. Full-Employment and the
Phillips Curve
Full-Employment Goal
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As the Phillips Curve shifts, the
full-employment goal shifts with it.
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As the institutional PPC changes in response to
society placing more (or removing) impediments to hiring and production, the
full-employment goal shifts.
What’s Next?
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We know that the
economy will begin to self-correct from either of the two economic problems:
¨ high unemployment in an underperforming economy
¨ high inflation in an overheated economy
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We know that
self-correction takes a long time and we are impatient.
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Next: We study
how the government can form a policy to “fix” the economy more rapidly.