The Phillips Curve and the Natural Rate of Unemployment — AP Macroeconomics
1. Core Concepts: The Phillips Curve and Natural Rate of Unemployment ★★☆☆☆ ⏱ 3 min
The Phillips Curve is a core macroeconomic model describing the relationship between inflation and unemployment, updated from early empirical work to account for long-run inflation expectation adjustments. This topic makes up 10-15% of AP Macroeconomics Unit 5, appearing in both MCQ and FRQ sections on nearly every exam.
The central insight of the modern Phillips Curve model is that a trade-off between inflation and unemployment exists only in the short run; no permanent trade-off exists in the long run, as inflation expectations adjust to actual inflation, shifting the short-run curve back to align with the long-run vertical curve at NRU.
2. The Short-Run Phillips Curve (SRPC) ★★★☆☆ ⏱ 4 min
The Short-Run Phillips Curve (SRPC) is a downward-sloping curve that shows the inverse relationship between inflation and unemployment when expected inflation and the natural rate of unemployment are held constant. The inverse relationship comes from short-run wage and price stickiness: unexpected increases in aggregate demand lead firms to raise output, hire more workers (lower unemployment), and push up prices (higher inflation).
pi = pi^e - alpha(u - u_n)
Where: $\pi$ = actual inflation, $\pi^e$ = expected inflation, $\alpha$ = a positive constant measuring how responsive inflation is to cyclical unemployment, $u$ = actual unemployment, and $u_n$ = the natural rate of unemployment. When actual unemployment falls below $u_n$, actual inflation rises above expected inflation, giving the SRPC its downward slope.
Exam tip: On AP FRQs, always label SRPC with a negative slope, axes (Y: Inflation Rate, X: Unemployment Rate), and remember that changes in AD cause movement along the SRPC, not a shift of the curve itself.
3. Long-Run Phillips Curve (LRPC) and Long-Run Equilibrium ★★★☆☆ ⏱ 4 min
In the long run, wages and prices are fully flexible, and workers adjust their inflation expectations to match actual inflation. Any attempt to keep unemployment below the natural rate via expansionary policy will only lead to permanently higher inflation, not sustained lower unemployment. This means the Long-Run Phillips Curve (LRPC) is a vertical line drawn exactly at the natural rate of unemployment $u_n$, with no trade-off between inflation and unemployment in the long run.
There is a direct 1:1 mapping between the LRPC and the long-run aggregate supply (LRAS) curve in the AD-AS model: LRAS is vertical at potential output, which corresponds to an unemployment rate exactly equal to the natural rate. If expansionary policy shifts AD right, output rises above potential, unemployment falls below $u_n$, and inflation rises in the short run. In the long run, workers adjust wage expectations, SRAS shifts left, output returns to potential, unemployment returns to $u_n$, and inflation is permanently higher, which corresponds to the SRPC shifting upward to intersect LRPC at the new higher inflation rate.
Exam tip: If a question asks how a change in frictional unemployment affects the Phillips curve, remember it shifts both LRPC and SRPC, since SRPC always intersects LRPC at the new NRU.
4. Shifts of the SRPC and LRPC ★★★★☆ ⏱ 3 min
It is critical to distinguish between movements along a curve and shifts of the entire curve, a common source of error on AP exams. Movements along the SRPC are only caused by changes in aggregate demand that change actual inflation and unemployment. Shifts of the SRPC are caused by two factors: (1) Changes in expected inflation: higher expected inflation shifts SRPC upward/rightward (higher inflation at every unemployment rate), lower expected inflation shifts it downward/leftward. (2) Aggregate supply shocks: a negative supply shock (e.g., rising oil prices) shifts SRPC up/right, a positive supply shock shifts it down/left.
Shifts of the LRPC are only caused by changes in the natural rate of unemployment, which stem from changes to labor market structure, frictional unemployment, or structural unemployment. For example, increased job training reduces structural unemployment, so NRU falls and LRPC shifts left. A permanent increase in the minimum wage raises structural unemployment, so NRU rises and LRPC shifts right.
Exam tip: On AP MCQs, if you are asked to identify the effect of a supply shock, always eliminate options that show a shift of LRPC unless the question explicitly states the shock changed the natural rate of unemployment.
Common Pitfalls
Why: Students confuse the short-run inverse relationship with the long-run relationship, memorizing the wrong slope.
Why: Students confuse the causes of movement vs shift, mixing up AD changes with expected inflation/supply shock changes.
Why: Students confuse 'no cyclical unemployment' with 'no unemployment' altogether.
Why: Students mix up direction of shift, incorrectly associating lower unemployment with lower inflation.
Why: Students treat the two models as separate, not linked.
Why: Students confuse short-run gains from expansionary policy with long-run outcomes.