The Phillips Curve — OCR A-Level Economics

The Phillips Curve illustrates an inverse relationship between unemployment and inflation, showing that lower unemployment leads to higher inflation and vice versa. In the long run, this trade-off disappears as expectations adjust, making the long-run Phillips Curve vertical at the natural rate of unemployment.

The Phillips Curve is a fundamental concept in macroeconomics that illustrates the relationship between inflation and unemployment. Named after economist A.W. Phillips, it originally showed an inverse relationship between wage inflation and unemployment in the UK from 1861-1957. This relationship implies that as unemployment falls, inflation tends to rise, and vice versa. The curve is a crucial tool for policymakers, as it suggests a trade-off between the two objectives of low inflation and low unemployment.

However, the original Phillips Curve was challenged in the 1970s when many economies experienced stagflation—high inflation and high unemployment simultaneously. This led to the development of the expectations-augmented Phillips Curve, which incorporates the role of inflation expectations. In the short run, the curve is downward sloping, but in the long run, it is vertical at the natural rate of unemployment. This means that any attempt to keep unemployment below the natural rate will result in accelerating inflation, not a permanent reduction in unemployment.

Understanding the Phillips Curve is essential for analysing macroeconomic policy, particularly the trade-offs faced by governments and central banks. It also connects to concepts like the natural rate of unemployment, adaptive and rational expectations, and the impact of supply-side policies. For OCR A-Level Economics, you need to be able to draw and interpret the Phillips Curve, explain shifts, and evaluate its relevance in modern economic policy.

• →Short-run Phillips Curve: Shows an inverse relationship between inflation and unemployment, assuming expectations are constant.
• →Long-run Phillips Curve: Vertical at the natural rate of unemployment, indicating no trade-off between inflation and unemployment in the long run.
• →Natural rate of unemployment: The rate of unemployment consistent with stable inflation, determined by supply-side factors.
• →Expectations-augmented Phillips Curve: Incorporates inflation expectations; when expectations adjust, the short-run curve shifts.
• →Stagflation: A situation of high inflation and high unemployment, which contradicts the original Phillips Curve.

• Definition and characteristics of public goods (non-excludability, non-diminishability/non-rivalry, non-rejectability, zero marginal cost)
• Explanation of the free rider problem
• Distinction between public, private, and quasi-public goods
• Identification of government intervention methods (taxation, subsidies, expenditure, price controls, buffer stocks, partnerships, legislation, regulation, tradable pollution permits, information provision, competition policy)
• Explanation of government failure
• Evaluation of the effectiveness of government intervention
• Evaluation of the causes and consequences of government failure

• 💡Ensure you can clearly define the four characteristics of a public good
• 💡When evaluating government intervention, always consider the potential for government failure
• 💡Use real-world examples of government intervention to support your evaluation
• 💡Be prepared to discuss why some goods are provided by the state even if they are not strictly public goods
• 💡Always draw and label the Phillips Curve diagram accurately, including the vertical long-run curve at the natural rate of unemployment.
• 💡Use the concept of expectations to explain shifts in the short-run Phillips Curve. Mention adaptive or rational expectations.
• 💡When evaluating, consider real-world examples like the 1970s stagflation and the impact of supply-side policies on the natural rate.

• Confusing public goods with state-provided goods
• Failing to distinguish between the causes of market failure and the causes of government failure
• Inadequate evaluation of the unintended consequences of government intervention
• Misapplying the concept of the free rider problem to private goods
• Misconception: The Phillips Curve implies that a government can permanently reduce unemployment by accepting higher inflation. Correction: In the long run, the Phillips Curve is vertical, so any such attempt leads to accelerating inflation without a permanent reduction in unemployment.
• Misconception: The Phillips Curve is a direct causal relationship. Correction: It is an empirical relationship that can be affected by supply shocks and expectations; it is not a fixed law.
• Misconception: The long-run Phillips Curve is also downward sloping. Correction: It is vertical because in the long run, expectations adjust, and unemployment returns to the natural rate regardless of inflation.

1. 1Week 1: Learn the basic Phillips Curve diagram and the original trade-off. Practice drawing and explaining the short-run curve.
2. 2Week 2: Understand the expectations-augmented Phillips Curve and the long-run vertical curve. Study the impact of expectations and the natural rate of unemployment.
3. 3Week 3: Apply the Phillips Curve to policy scenarios and evaluate its usefulness. Practice past exam questions and model answers.

• 📋Diagram-based questions: Draw and explain the short-run and long-run Phillips Curve.
• 📋Data response questions: Analyse data on inflation and unemployment to identify the relationship.
• 📋Essay questions: Evaluate the usefulness of the Phillips Curve for macroeconomic policy.
• 📋Multiple choice questions: Test understanding of the shape and shifts of the curve.