The Phillips Curve Study Pack

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Last updated May 21, 2026

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The Phillips Curve Study Guide

Trace the evolution of the Phillips Curve from A.W. Phillips's original inverse relationship between inflation and unemployment to the Friedman-Phelps expectations-augmented model and the vertical long-run curve. This pack covers the natural rate of unemployment, stagflation's challenge to the stable tradeoff, and how supply shocks and shifting inflation expectations move the short-run curve.

Key Takeaways

  • •The Phillips Curve describes an inverse relationship between inflation and unemployment: when unemployment falls, inflation tends to rise, and vice versa.
  • •The original short-run Phillips Curve was derived from A.W. Phillips's 1958 analysis of wage inflation and unemployment data in the United Kingdom spanning nearly a century.
  • •Economists Milton Friedman and Edmund Phelps independently argued in the late 1960s that the short-run tradeoff disappears in the long run because workers and firms adjust their expectations about inflation.
  • •The long-run Phillips Curve is a vertical line at the natural rate of unemployment, meaning monetary policy cannot permanently reduce unemployment below that rate by accepting higher inflation.
  • •Stagflation in the 1970s — simultaneous high inflation and high unemployment — empirically challenged the original stable tradeoff and supported the Friedman-Phelps expectations-augmented model.
  • •Shifts in the short-run Phillips Curve occur when expected inflation changes or when supply shocks alter the underlying cost structure of the economy.
  • •The natural rate of unemployment is not fixed; structural changes in labor markets, demographics, and policy can shift it over time.

Origins and the Basic Inflation-Unemployment Tradeoff

The Phillips Curve emerged from empirical observation before it became a theoretical framework, and understanding its origins clarifies both what it claims and what its limits are.

A.W. Phillips's 1958 Discovery

  • •British economist A.W. Phillips plotted wage inflation against unemployment rates in the UK from 1861 to 1957 and found a consistent downward-sloping curve.
  • •American economists Paul Samuelson and Robert Solow extended the analysis to the United States and reframed the relationship using price inflation rather than wage inflation.
  • •The core finding: when labor markets are tight and unemployment is low, employers compete for workers and bid up wages, pushing prices higher; when unemployment is high, wage and price pressures ease.

Interpreting the Downward Slope

  • •A movement along the short-run Phillips Curve represents a policy tradeoff — policymakers could theoretically 'choose' a point on the curve by adjusting aggregate demand through monetary or fiscal policy.
  • •Lower unemployment corresponds to an economy operating near or above potential output, generating inflationary pressure from increased spending and higher input costs.
  • •Higher unemployment indicates slack in the economy — unused labor and capital — which suppresses wage growth and keeps inflation low.

The Short-Run Phillips Curve and Aggregate Demand

The short-run Phillips Curve is best understood as a summary of how demand-side fluctuations affect both the labor market and the price level simultaneously.

Connecting the Phillips Curve to the AD-AS Framework

  • •When aggregate demand increases — through government spending, tax cuts, or monetary expansion — output rises, firms hire more workers, unemployment falls, and prices rise: movement down and to the left along the short-run Phillips Curve.
  • •When aggregate demand contracts, output falls, firms lay off workers, unemployment rises, and price pressure subsides: movement up and to the right along the curve.
  • •The short-run Phillips Curve therefore reflects a snapshot of the economy at a given level of inflation expectations and given supply conditions.

Why the Short-Run Tradeoff Exists

  • •In the short run, some wages and prices are 'sticky' — set by contracts or convention — so firms respond to higher demand partly by raising output and hiring rather than immediately raising prices.
  • •This stickiness means that a demand stimulus can temporarily reduce unemployment even as inflation only gradually accelerates.
  • •The tradeoff is explicitly short-run: it holds only as long as inflation expectations remain anchored at their previous level.

About this Study Pack

Created by Kibin to help students review key concepts, prepare for exams, and study more effectively. This Study Pack was checked for accuracy and curriculum alignment using authoritative educational sources. See sources below.

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