Phillips curve (HL only)
IB Economics Higher Level· IB Economics Guide 2020: Macroeconomics 3.6· 20 min read
1. Short-run Phillips Curve (SRPC)★★☆☆☆⏱ 7 min
Short-run Phillips Curve
A downward-sloping curve that shows the inverse (negative) relationship between the rate of inflation and the rate of unemployment in the short run, when nominal wages and inflation expectations are sticky.
Example:
A positive aggregate demand shock lowers unemployment and raises inflation, causing an upward movement along the existing SRPC.
The inverse relationship arises because nominal wages are slow to adjust in the short run. When aggregate demand increases, firms raise prices in response to higher consumer spending, and increase output by hiring more workers, reducing unemployment. Since nominal wages have not adjusted yet, real wages fall, making higher employment profitable for firms.
An economy starts at equilibrium with 2% inflation and 5% unemployment. The central bank implements expansionary monetary policy that increases aggregate demand, pushing inflation up to 4%. Predict the change in unemployment using the SRPC model.
- 1
The SRPC is downward-sloping, meaning higher inflation is associated with lower unemployment, all else equal.
- 2
Expansionary policy causes a movement up along the existing SRPC, it does not shift the curve.
- 3
Starting from (5% unemployment, 2% inflation), the new 4% inflation rate corresponds to an unemployment rate lower than the original 5%.
- 4\begin{tikzpicture}[scale=0.8] \draw[->] (0,0) -- (6,0) node[right] {Unemployment ($u$)}; \draw[->] (0,0) -- (0,5) node[above] {Inflation ($\pi$)}; \draw[thick, blue] (1,4) -- (5,1) node[right] {SRPC}; \fill (3,2.5) circle (2pt) node[above left] {A$(5\%, 2\%)$}; \fill (2,3.5) circle (2pt) node[below right] {B$(3\%, 4\%)$}; \end{tikzpicture}
- 5
The new short-run equilibrium is 3% unemployment and 4% inflation, confirming the short-run trade-off.
Exam tip:
Always label axes correctly for Phillips curve diagrams: inflation goes on the vertical axis, unemployment on the horizontal axis — do not mix this up with AD-AS axes.
2. Long-run Phillips Curve (LRPC)★★★☆☆⏱ 8 min
Long-run Phillips Curve
A vertical curve at the natural rate of unemployment () that shows there is no permanent trade-off between inflation and unemployment in the long run, once all nominal wages and inflation expectations have adjusted fully.
In the long run, workers adjust their inflation expectations to match actual inflation. If inflation remains higher than expected, workers will negotiate higher nominal wages in the next bargaining round, increasing firms' production costs. Higher costs lead firms to reduce output and employment, pushing unemployment back to the natural rate, but leaving inflation at its new higher level.
Continuing from the earlier example: after expansionary policy moves the economy to 4% inflation and 3% unemployment, what happens in the long run? Describe the impact on the Phillips curve.
- 1
In the short run, inflation expectations are fixed, so the economy remains at 3% unemployment and 4% inflation.
- 2
Over time, workers observe that inflation has risen from 2% to 4%, so they update their inflation expectations and negotiate higher nominal wages to match the new higher price level.
- 3
Higher nominal wages increase firms' costs, so firms reduce employment, and unemployment rises back to the natural rate of 5%, while inflation stays at 4%.
- 4\begin{tikzpicture}[scale=0.8] \draw[->] (0,0) -- (6,0) node[right] {Unemployment ($u$)}; \draw[->] (0,0) -- (0,5) node[above] {Inflation ($\pi$)}; \draw[thick, red!80] (3,0) -- (3,5) node[above] {LRPC}; \draw[thick, blue] (1,4) -- (5,1) node[right] {SRPC$_1$}; \draw[thick, blue] (2,4.5) -- (4,1.5) node[right] {SRPC$_2$}; \fill (3,2) circle (2pt) node[below left] {$(u_n=5\%, 2\%)$}; \fill (3,4) circle (2pt) node[below right] {$(u_n=5\%, 4\%)$}; \end{tikzpicture}
- 5
The SRPC shifts upward to match the new higher inflation expectations, and the long-run equilibrium lies on the vertical LRPC at the natural rate of unemployment. There is no long-run trade-off.
3. Shifts and Policy Implications★★★☆☆⏱ 5 min
Shifts of the SRPC are caused by changes in inflation expectations or supply-side shocks (like changes in global oil prices, or changes in structural unemployment). Shifts of the LRPC only occur when the natural rate of unemployment itself changes, for example after labour market reforms or a rise in structural unemployment.
A positive supply shock (e.g. falling oil prices) shifts SRPC inward (left/down), lowering both inflation and unemployment at any equilibrium.
A negative supply shock (e.g. rising oil prices) shifts SRPC outward (right/up), causing stagflation (higher inflation and higher unemployment).
Labour market reforms that reduce frictional unemployment shift both LRPC and SRPC left, lowering the natural rate of unemployment.
Global oil prices double, causing a negative supply shock. What is the impact on SRPC, LRPC, and equilibrium outcomes?
- 1
A negative supply shock increases production costs, raising inflation at every level of unemployment.
- 2
The natural rate of unemployment has not changed, so the LRPC remains in its original position.
- 3
The entire SRPC shifts upward (rightward), leading to a new equilibrium with higher inflation and higher unemployment than before the shock, even if aggregate demand remains unchanged.
4. Common Pitfalls
Wrong move:
Confusing movement along the SRPC with a shift of the SRPC
Why:
Attributing changes from aggregate demand shifts to shifts of the SRPC, when only expectations or supply shocks shift the curve
Correct move:
Changes in aggregate demand cause movements along a fixed SRPC; changes in expectations or supply shocks shift the entire SRPC
Wrong move:
Drawing the LRPC as downward or upward sloping
Why:
Forgetting that all prices and expectations adjust fully in the long run, eliminating any trade-off
Correct move:
The LRPC is always vertical at the natural rate of unemployment, regardless of the inflation rate
Wrong move:
Claiming there is always a trade-off between inflation and unemployment
Why:
Ignoring the long-run adjustment of inflation expectations
Correct move:
A trade-off only exists in the short run; there is no permanent trade-off in the long run
Wrong move:
Mixing up the axes on Phillips curve diagrams
Why:
Confusing Phillips curve axes with AD-AS axes, leading to lost marks in diagram questions
Correct move:
Always label the vertical axis as inflation rate and horizontal axis as unemployment rate
5. Quick Reference Cheatsheet
Concept | Shape | Key Property | Cause of Shifts |
|---|---|---|---|
Short-run Phillips Curve | Downward-sloping | Inverse short-run inflation-unemployment trade-off | Changes in inflation expectations, supply shocks |
Long-run Phillips Curve | Vertical at | No permanent trade-off between inflation and unemployment | Changes in the natural rate of unemployment |
Movement along SRPC | N/A | Caused by aggregate demand changes | Expansionary/contractionary demand-side policy |
6. Frequently Asked
Is there any trade-off between inflation and unemployment in the long run?
No, per the standard IB model, there is no permanent long-run trade-off. Any attempt to hold unemployment below the natural rate only results in permanently higher inflation, not sustained lower unemployment.
When this came up on past exams
AI-estimated based on syllabus patterns — cross-check with official past papers for accuracy. Use only as revision-focus signals.
- 2025 · 1
10 mark distinction SRPC/LRPC
- 2024 · 2
2 mark shift of SRPC explanation
- 2023 · 1
15 mark policy evaluation
- 2022 · 2
4 mark diagram drawing
Going deeper
What's Next
The Phillips curve is a core model for IB Economics HL that connects inflation, unemployment, and macroeconomic policy, directly building on your understanding of the AD-AS framework and the natural rate of unemployment. It is frequently tested in both Paper 1 essay and Paper 2 data response questions, so mastering the difference between short-run and long-run outcomes is critical for achieving high marks. The model also provides a foundation for analyzing the trade-offs policymakers face when responding to shocks like supply side price increases.