Cambridge International as and a level Economics Ebook

Phillips curve: 
a curve that shows the relationship 
between the unemployment rate and the inflation rate over 
a period of time.
KEY TERM
However, this interpretation supported by Keynesians is 
questioned by monetarists. Th
ey argue that, while there 
may be a short-run trade-off , in the long run government 
policy measures to increase aggregate demand will have no 
impact on unemployment but will only succeed in raising 
the infl ation rate. To support this view, Milton Friedman 
developed the
 expectations-augmented Phillips curve
, as 
shown by the vertical line in 
Figure 10.3.
 Th
e position of this 
line is determined by the natural rate of unemployment.
Expectations-augmented Phillips curve: 
a diagram 
that shows that while there may be a trade-off between 
unemployment and inflation in the short run, there is no 
trade-off in the long run.
KEY TERM
Figure 10.3
 shows that an increase in aggregate demand 
does succeed in reducing unemployment from the 
previous 8% to 4% but creates infl ation of 5% and moves 
the economy on to a higher short-run Phillips curve. Firms 
expand their output and more people are attracted into 
the labour force as a result of the higher wages. However, 
when fi rms realise that their costs have risen and their real 
profi ts are unchanged, they will cut back on their output 
0
Inflation %
Unemployment %
Figure 10.2 
The Phillips curve
Inflation %
4
8
12
0
5
SPC
1
SPC
2
LPC
SPC
1
SPC
2
Unemployment %
SPC
SPC
Figure 10.3 
The expectations-augmented Phillips curve
267
Chapter 10: Government macro intervention 

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and some workers, recognising that real wages have not 
risen, will leave the labour force. Unemployment returns 
to 8% in the long run but infl ation of 5% has now been 
built into the system. Firms and workers will presume that 
infl ation will continue at 5% when deciding on their prices 
and putting in their wage claims. Another attempt to 
reduce unemployment to 4% will now eventually move the 
economy to SPC2 and push up the infl ation rate to 12%.