Economics 3307

Main Points of Mankiw, Chapter 13

Aggregate Supply

1. In this chapter we consider only the non-technical points of Section 13-2, which deals with the Phillips Curve. "Non-technical points" means that you do not need to study in detail the algebra in Section 13-2.

2. The (short-run) Phillips Curve is a downward-sloping relationship between inflation and unemployment. Inflation is on the horizontal axis (y-axis), and the unemployment rate is on the vertical axis (x-axis).

3. The (short-run) Phillips Curve is drawn for a given expected rate of inflation. When expected inflation increases, the (short-run) Phillips Curve shifts upward. When expected inflation decreases, inflation shifts downward.

4. The Long-Run Phillips Curve is a vertical line at the natural rate of unemployment. This means that when actual inflation equals expected inflation, unemployment is equal to the natural rate.

5. When inflation is higher than expected (p > p^e), then unemployment is below the natural rate.

6. When inflation is lower than expected (p < p^e), then unemployment is above the natural rate.

7. For all practical purposes, we can think of the Phillips Curve as a kind of aggregate supply curve. What makes this a little weird is that in the Phillips Curve graph there is no corresponding curve for aggregate demand. Thus as you move up and down along a Phillips Curve, you have to visualize the appropriate change in aggregate demand (more on this below).

8. The long run aggregate supply (LRAS) curve is vertical, and so is the long-run Phillips Curve. In the long-run, changes in aggregate demand affect only prices and have no effect on either output (in the AS/AD graph) or unemployment (in the Phillips Curve graph)

9. In the AS/AD model discussed in Chapters 9-11, the SRAS curve is horizontal: in the short-run, a change in AD raises output and has no effect at all on price. With the Phillips Curve model, this is not quite true. In that model, a rise in AD growth causes a decline in unemployment (which corresponds to a rise in output growth) and an increase in inflation. Prices are affected in the short-run in the Phillips Curve model. So, really, the short-run Phillips Curve is more consistent with an upward-sloping SRAS curve than with a horizontal SRAS curve.

10. All this may seem a bit confusing, but there really isn't very much new here. In the AS/AD model, an increase in AD will increase Y in the short-run and P in the long-run. Somewhere in the transition from short-run to long-run equilibrium, both P and Y are higher than before the rise in AD. This is consistent with what the Phillips Curve says -- as long as we remember to interpret the changes in Y and P in the AS/AD graph as changes relative to trend. The rise in Y relative to trend is a temporary rise in output growth (which, from Okun's Law, we know corresponds to a fall in unemployment). The rise in P relative to trend is a temporary rise in inflation.

11. Movements up and down a short-run Phillips Curve reflect a situation in which the economy is being affected primarily by exogenous changes in AD. If the economy is being drive by exogenous changes in aggregate supply, the short-run relationship between inflation and unemployment given by a short-run Phillips Curve will not hold.