The Philips curve is an economic concept developed by A.W.

Phillips stating that inflation and

unemployment have a stable and inverse relationship. The theory claims that with economic
growth comes inflation, which in turn should lead to more jobs and less unemployment.
It was proposed in 1958 by economist A.W. Phillips. In his original paper, Phillips tracked wage
changes and unemployment changes in Great Britain from 1861 to 1957, and found that there
was a stable, inverse relationship between wages and unemployment.
However, the original concept has been somewhat disproven empirically due to the occurrence
of STAGFLATION in the 1970s, when there were high levels of both inflation and
unemployment, because it contradicted the idea of the said curve.
Why is there a trade-off between Unemployment and Inflation?
 Changes I aggregate demand translate as movements along the Phillips Curve. For
instance, if the economy experiences a rise in AD, it will cause increased output.
 As the economy comes closer to full employment, we also experience a rise in inflation.
 However, with the increase in real GDP, firms take on more workers leading to a decline
in unemployment (a fall in demand deficient unemployment)
 Thus, with faster economic growth in the short-term, we experience higher inflation and
lower unemployment.

Economic Output
 In economics, output is the quantity of goods and services produced in each time period.
The level of output is determined by both the aggregate supply and aggregate demand
within an economy. National output is what makes a country rich, not large amounts of
money.
 Anything that causes labor, capital, or efficiency to go up or down results in fluctuations
in economic output.

Fluctuations in output
 SHORT RUN – output fluctuates with shifts in either aggregate supply or aggregate
demand.
 LONG RUN – only aggregate supply affects output.
SHORT RUN VS. LONG RUN

SHORT RUN
 Outward shift in the aggregate supply curve would result in increased output and lower
prices.
 Outward shift in the aggregate demand curve would also increase output and raise prices
 Increase in money will increase production due to shift in the aggregate supply.
  More goods are produced because the output is increased and more goods are bought
because of the lower price.

LONG RUN
 The aggregate supply curve and aggregate demand curve are only affected by capital,
labor, and technology.
 Everything in the company is assumed to be optimal
 The aggregate supply curve is vertical which reflects economists belief that changes in
aggregate demand only temporarily change the economy’s total output.
 An increase in money will do nothing for output, but will increase prices

CLASSICAL THEORY
Classical economics focuses on the growth in the wealth of nations and promotes policies that
create national expansion. During this time period, theorists developed the theory of value of
price which allowed for further analysis of markets and wealth. It analyzed and explained the
price of goods and services in addition to the exchange value.
ASSUMPTIONS
 Supply creates its own demand; based on Say’s Law, classical theorists believed that
supply creates its own demand. Production will generate an income enough to purchase
all of the output produced. Classical economics assumes that there will be a net saving or
spending of cash or financial instruments.
 Equality of savings and investment; classical theory assumes that flexible interest rates
will always maintain equilibrium.
 Calculating real GDP classical theorists determined that the real GDP can be calculated
without knowing the money supply or inflation rate.
 Real and nominal variables classical economists stated that the real and nominal variables
can be analyzed separately