Why You Need a Second Graph for the Same Story
By the end of Unit 4, you had built a fairly powerful machine: the AD-AS model, plus the money market, plus the loanable funds market. With those tools, you can already answer most "what happens to the economy when X changes" questions. So why does Unit 5 introduce yet another graph — the Phillips Curve?
Because the AP exam — and the actual policy debate in the real world — cares about two specific variables: the inflation rate and the unemployment rate. These are the two numbers people see in news headlines, the two numbers politicians get judged on, and the two numbers the Federal Reserve writes into its mandate. The AD-AS model tells you about prices and output. The Phillips Curve translates that same story into the language of inflation and unemployment.
Here's the punchline of this section, so you know where we're heading:
- In the short run, there is a trade-off: lower unemployment comes with higher inflation, and vice versa. The Phillips Curve slopes downward.
- In the long run, that trade-off vanishes. The economy returns to a fixed unemployment rate (the Natural Rate, or NRU) no matter what the inflation rate is. The long-run Phillips Curve is vertical.
- The bridge between short run and long run is inflation expectations. When workers update what they think future inflation will be, the short-run curve shifts.
Get those three ideas locked in, and the rest of Unit 5 — fiscal vs. monetary policy in the long run, crowding out, even economic growth — falls into place naturally. Let's build it.
📝 The FRQ pattern you're being prepared for: "Using a correctly labeled graph of the short-run and long-run Phillips Curves, show the short-run and long-run effects of an increase in government spending." This kind of dual-graph FRQ has appeared on nearly every recent AP exam. Every shift, every point label, every direction matters — and they're each worth a point. By the end of this section, drawing this from memory will be automatic.
The Short-Run Phillips Curve (SRPC)
Picture a busy job market where employers are scrambling to find workers. With so few unemployed people available, employers have to offer higher wages to attract talent. Those higher wages flow into the cost of producing goods, and firms pass the cost along in higher prices. Low unemployment ends up generating higher inflation. Now flip it: in a slack labor market with lots of unemployed people, employers don't have to raise wages much, costs stay flat, and prices rise slowly. High unemployment ends up generating low inflation. That inverse relationship is the Short-Run Phillips Curve.
Short-Run Phillips Curve (SRPC): A downward-sloping curve showing the inverse relationship between the unemployment rate (on the x-axis) and the inflation rate (on the y-axis) in the short run. In the short run, policymakers face a trade-off: they can buy lower unemployment by accepting higher inflation, or buy lower inflation by accepting higher unemployment.
Where the Trade-Off Comes From (AD-AS Connection)
The Phillips Curve isn't a new theory. It's the AD-AS model's twin — just plotted on different axes. Watch what happens when AD shifts right:
AD shifts right (expansionary policy)
A central bank cut, a tax cut, or a spending increase pushes the AD curve outward.
Real GDP rises, unemployment falls
Firms produce more, so they hire more workers. The unemployment rate dips below its previous level.
Tight labor market pushes wages up
With fewer unemployed workers competing for jobs, employers have to raise wages to attract and keep employees.
Firms pass higher costs to consumers
Higher wages mean higher production costs. Firms raise prices to protect their profit margins. The price level rises faster — that is, inflation rises.
Result on the Phillips Curve
Lower unemployment + higher inflation = a movement up and to the left along the SRPC. The trade-off is visible.
Contractionary policy works the same way in reverse: AD shifts left, output falls, unemployment rises, wages stall, inflation drops. The economy moves down and to the right along the SRPC. Same curve, opposite direction.
The Graph You Need to Be Able to Draw
Notice what the graph is and isn't telling you. It is telling you the combinations of inflation and unemployment that are possible in the short run. It is not telling you which combination is "best" — that's a political and ethical question, not an economic one. A central banker who hates inflation will choose to be near point C. A politician who hates unemployment will push for point A. The Phillips Curve just shows you the menu.
🎯 Memorize this exam pattern: Movement ALONG the SRPC is caused by shifts in aggregate demand. Shifts OF the SRPC are caused by changes in inflation expectations or supply shocks. Get that distinction wrong and you'll lose easy points. We'll do shifts in the next section.
The Long-Run Phillips Curve (LRPC)
So far, so good — if the trade-off were the whole story, every government would just choose its preferred mix of inflation and unemployment, and we'd all live happily ever after. But there's a catch, and it's the catch that defines modern macroeconomics: the trade-off only works while inflation is a surprise. Once people figure out what inflation is actually doing, they adjust, and the trade-off evaporates.
Long-Run Phillips Curve (LRPC): A vertical line drawn at the Natural Rate of Unemployment (NRU). It tells us that in the long run, there is no trade-off between inflation and unemployment. Whatever the inflation rate ends up being, the economy returns to the NRU. Demand-side policies don't lower unemployment permanently — they only change the inflation rate.
The Story That Makes the LRPC Vertical
Imagine the Fed cuts interest rates aggressively to fight a recession. What happens, step by step?
Inflation rises faster than workers expected
Workers signed wage contracts last year based on, say, 2% expected inflation. The Fed's expansion pushes actual inflation to 4%. Workers' real wages quietly fall.
Firms exploit the "discount" on labor
With real wages temporarily low, firms find it cheap to hire. They produce more. Unemployment falls below the NRU. We move along SRPC₀ to a point with lower u and higher π.
Workers catch on and renegotiate
Workers eventually realize inflation is running at 4%, not 2%. When their contracts expire, they demand 4% raises just to keep their old real wage — plus any future expected inflation.
Higher wages = higher costs = SRPC shifts up
Firms now face higher wage bills. They cut back hiring or raise prices even more. The SRPC shifts upward to SRPC₁: at every unemployment rate, inflation is now higher.
Unemployment returns to the NRU
With wages back up to match inflation, firms have no reason to keep hiring extra workers. Unemployment slides back to the NRU. The trade-off the Fed seemed to buy has evaporated — all we have left is higher inflation.
That's why the LRPC is vertical: once workers fully understand the inflation rate and bake it into their wage demands, unemployment has to return to its "natural" level. The economy can't permanently stay below the NRU just by accepting higher inflation. The trade-off is short-run only.
The Master Graph: SRPC₀, SRPC₁, and the LRPC Together
This is the graph of Unit 5. If you can draw this from memory — three labeled points, two SRPCs, one LRPC, and arrows showing the short-run and long-run movements — you can answer almost every FRQ in this unit. Practice drawing it five times today. Cover the picture and reproduce it from memory. This is muscle memory more than book knowledge.
The "A → B → C" Story
A for Anchor: long-run equilibrium at the NRU, where SRPC and LRPC intersect.
B for Boom (short run): expansion pushes us along the SRPC to lower unemployment and higher inflation.
C for Catch-up (long run): expectations adjust, SRPC shifts up, unemployment goes back home to NRU — but inflation is permanently higher than where we started.
The AD-AS ↔ Phillips Curve Mirror
The Phillips Curve and the AD-AS model are telling the exact same story on different sets of axes. Treat them as two windows looking into the same room:
| Concept | AD-AS Model | Phillips Curve |
|---|---|---|
| Y-axis | Price Level (PL) | Inflation rate (π) — the rate of change of PL |
| X-axis | Real GDP (Y) | Unemployment rate (u) — inversely related to Y |
| Long-run anchor | LRAS is vertical at Yf (full employment output) | LRPC is vertical at NRU (natural rate of unemployment) |
| Above potential | Y > Yf (inflationary gap) | u < NRU (cyclical unemployment is negative) |
| Below potential | Y < Yf (recessionary gap) | u > NRU (cyclical unemployment is positive) |
| Long-run adjustment | SRAS shifts to restore Y = Yf | SRPC shifts to restore u = NRU |
Yf and NRU describe the same economic state from different angles. At full-employment output, the unemployment rate is the NRU. When you say "the long-run AD-AS model returns to Yf," you're saying the same thing as "the long-run Phillips Curve returns to NRU." Internalize this equivalence and you'll never miss a "long-run effect" question.
What Makes the Phillips Curves Shift?
Movement along the SRPC is caused by changes in AD. Shifts of the SRPC have completely different causes — and confusing the two is the single most common mistake on Unit 5 FRQs. Same goes for the LRPC, which has its own (very different) set of shifters. Let's lock down both.
Shifters of the SRPC
The SRPC shifts when something changes the inflation-unemployment trade-off itself — that is, when at a given level of unemployment, the inflation rate is different than before. Two big drivers do this:
SRPC shifts UP/RIGHT
What changes: Workers expect higher inflation, so they demand higher wages in contracts; firms expect higher costs and raise prices preemptively.
Result on graph: At every unemployment rate, the inflation rate is higher than before.
Example trigger: The Fed announces aggressive money supply growth; recent inflation has been high so people extrapolate.
SRPC shifts DOWN/LEFT
What changes: Workers expect lower inflation; wage demands moderate; firms expect stable costs.
Result on graph: At every unemployment rate, the inflation rate is lower than before.
Example trigger: The Fed gains credibility with a sustained anti-inflation stance; recent inflation has been low.
SRPC shifts UP/RIGHT
What changes: A sudden rise in production costs (oil, raw materials, supply chain disruption). Firms charge more and produce less.
Result on graph: Higher inflation and higher unemployment together — the trade-off worsens.
Example trigger: OPEC oil embargo (1973), pandemic supply disruptions (2020-2021).
SRPC shifts DOWN/LEFT
What changes: A sudden drop in production costs or improvement in productivity. Firms can charge less and still hire more.
Result on graph: Lower inflation and lower unemployment together — a policymaker's dream.
Example trigger: Sustained drop in oil prices, technological breakthroughs that lower production costs broadly.
Shifters of the LRPC
The LRPC sits at the Natural Rate of Unemployment. So the only thing that can shift the LRPC is something that changes the NRU itself. The NRU is determined by structural features of the labor market — it has nothing to do with inflation, AD, or monetary policy.
| Cause | Effect on LRPC |
|---|---|
| Improved job matching (better online job platforms, better information) | NRU falls → LRPC shifts LEFT |
| Better worker training and education | NRU falls → LRPC shifts LEFT |
| Reduced minimum wage / less restrictive labor laws | NRU falls → LRPC shifts LEFT |
| Reduced unemployment benefits (less incentive to stay unemployed) | NRU falls → LRPC shifts LEFT |
| Aging population, more workers in transition | NRU rises → LRPC shifts RIGHT |
| Skill mismatches (workers' skills don't match available jobs) | NRU rises → LRPC shifts RIGHT |
⚠️ The trap that fails students every year: "Increased government spending shifts the LRPC right." WRONG. Government spending is a demand-side policy. It can shift AD (and create movement along the SRPC), but it can't move the LRPC. Only changes to structural labor market factors shift the LRPC. If you ever pick an option that says fiscal or monetary policy shifts the LRPC, you've fallen for the trap.
Mapping a Policy to Movement vs. Shift
Question: The Federal Reserve buys government bonds in the open market. Describe the effect on the SRPC.
Step 1 — Identify what kind of policy this is: Open market purchase by the Fed → expansionary monetary policy → AD shifts right.
Step 2 — Movement vs. shift? A shift in AD causes a movement along the SRPC, not a shift of it. The SRPC itself doesn't move yet.
Step 3 — Direction: Lower unemployment, higher inflation. Movement up and to the left along SRPC.
Step 4 — Long-run twist: Eventually, expectations adjust, and the SRPC shifts up as πe rises. Then the economy slides up the LRPC back to the NRU at higher inflation.
Stagflation: When the Trade-Off Breaks
For decades after Phillips's original work, economists thought the inflation-unemployment trade-off was a stable, dependable relationship. Pick your point, set monetary and fiscal policy accordingly, and the economy would oblige. Then the 1970s happened. The U.S. economy did something the Phillips Curve said shouldn't be possible: inflation and unemployment both went up at the same time. Stagflation — stagnation plus inflation — humiliated the simple Phillips Curve model and forced economists to rethink the framework.
Stagflation: The unusual situation in which both the inflation rate and the unemployment rate rise simultaneously. On the AD-AS model, stagflation shows up as a leftward shift of SRAS. On the Phillips Curve, it shows up as a rightward (upward) shift of the SRPC. The cause is almost always a negative supply shock.
Why Negative Supply Shocks Cause Stagflation
Think about what happens when oil prices quadruple overnight (as they did in 1973). Every business that uses energy — and that's essentially every business — suddenly has higher production costs. Two things happen at once:
- Firms raise prices to cover the higher costs → inflation rises.
- Firms produce less and lay off workers because their costs are higher and demand for their now-pricier goods is weaker → unemployment rises.
That's stagflation in a nutshell. The economy moves to a point with both more inflation and more unemployment — which means it can't be on the same SRPC as before. The whole SRPC has shifted to a worse position.
Seeing Stagflation on Both Graphs
AD-AS Model: SRAS shifts LEFT
Output falls; price level rises. Both unemployment (output side) and inflation (price side) get worse.
Phillips Curve: SRPC shifts UP/RIGHT
Both inflation and unemployment rise. The SRPC has shifted to a worse position — the trade-off is now less favorable.
The Cruel Policy Dilemma
Here's why stagflation is so dangerous from a policy perspective. Normally, the central bank has a clear move: if unemployment is too high, expand AD; if inflation is too high, contract AD. During stagflation, both problems are happening at the same time. Pick one and you make the other worse:
Option A: Fight unemployment
Expand AD (cut interest rates, raise government spending).
Result: Unemployment falls, but inflation gets even worse.
Option B: Fight inflation
Contract AD (raise interest rates, cut spending).
Result: Inflation comes down, but unemployment gets even worse.
The historical answer (from the early 1980s under Fed Chair Paul Volcker) was painful: deliberately accept a deep recession to crush inflation expectations and shift the SRPC back down. It worked, but unemployment hit double digits in the process. That brutal episode is the textbook lesson on why preventing inflation expectations from getting unmoored is so important.
Diagnosing a Supply Shock vs. a Demand Shock
Scenario: An AP question tells you: "Inflation rose from 3% to 6%, and unemployment rose from 5% to 7%, over the past year." What kind of shock most likely hit the economy?
Step 1 — Compare to standard SRPC story: The standard trade-off says inflation and unemployment move in opposite directions. Here, they moved in the same direction. So the economy didn't move along a single SRPC — the SRPC itself shifted.
Step 2 — Direction of the shift: Higher inflation at a higher unemployment rate means the SRPC shifted up/right. The trade-off worsened.
Step 3 — Identify the cause: An SRPC shift up/right is caused by either (a) a rise in expected inflation, or (b) a negative supply shock. Both are possible, but supply shocks are the classic cause of same-direction movements in inflation and unemployment.
Common Misconceptions
The Phillips Curve is conceptually subtle. Each of the misconceptions below has shown up as a wrong answer choice on real AP exams. Read carefully — getting one of these wrong on the exam costs an easy point.
- "The Phillips Curve shows a permanent trade-off between inflation and unemployment." Only in the short run. The LRPC is vertical at the NRU — there is no long-run trade-off. Trying to permanently keep unemployment below NRU just produces accelerating inflation.
- "Higher AD shifts the SRPC right." Wrong. Higher AD causes movement along the SRPC. Shifts of the SRPC come from changes in expected inflation or from supply shocks — not from AD shifts.
- "The LRPC is downward sloping in the long run." No — it's vertical. Mixing up the slopes of SRPC and LRPC is the single most common error.
- "Government spending or monetary policy can shift the LRPC." Wrong. Demand-side policies don't change the NRU. Only structural labor-market changes shift the LRPC.
- "Stagflation means the Phillips Curve disappeared." No — the Phillips Curve still exists. It just shifted to a worse position (the SRPC shifted up/right). The downward-sloping trade-off is still there; it's just less favorable than before.
- "If inflation expectations don't change, the long-run effect is the same as the short-run effect." Wrong by definition. The long run is defined as the time period during which expectations have adjusted. If they don't adjust, you're still in the short run.
- "The NRU is zero unemployment." No — the NRU is the unemployment rate at full employment, which still includes frictional and structural unemployment. The NRU is typically 4-5% in modern advanced economies, not zero.
- "A point to the left of the LRPC is impossible." Not impossible — it just isn't sustainable. The economy can temporarily operate to the left of the LRPC (unemployment below NRU) in the short run. Long-run pressure pushes it back to the LRPC.
- "All shifts of the SRPC are caused by changes in expected inflation." Most are, but supply shocks also shift the SRPC. Don't forget that channel — it's the source of stagflation.
- "The vertical LRPC means monetary policy is useless." Not useless — just limited. Monetary policy can stabilize the economy in the short run, set inflation expectations, and prevent crises. It just can't permanently lower unemployment below the NRU.
⚡ 5.1 Quiz: 5 Questions
Click an answer to lock it in. Every option gets a full breakdown — what's right, what's wrong, and the AP-favorite trap each distractor is designed to catch.
1. Which of the following is most accurately depicted by a movement along a stationary short-run Phillips Curve?
✓ Correct answer: (B)
Movement along the SRPC is the visualization of the short-run trade-off — and that trade-off is driven by changes in aggregate demand. When AD shifts right, output rises, unemployment falls, and inflation rises: the economy slides up and to the left along the existing SRPC. When AD shifts left, the economy slides down and to the right. The SRPC itself does not move; only the equilibrium point on it changes.
Why the other options miss the mark
- (A) A change in expected inflation shifts the entire SRPC up or down. The curve doesn't stay stationary.
- (C) A change in the NRU shifts the LRPC (and indirectly the SRPC at the NRU intersection). The curve moves.
- (D) A negative supply shock shifts the SRPC up/right (causing stagflation). The curve moves.
- (E) Productivity growth is a long-run growth effect — it shifts the LRPC and LRAS, not movement along the SRPC.
🔗 Review: Re-read "The Short-Run Phillips Curve" and the AD→SRPC connection chain. The clean rule: AD shifts cause movement; expectations and supply shocks cause shifts.
2. The economy is initially at full employment. The government implements an expansionary fiscal policy. According to the Phillips Curve framework, what is the most likely long-run outcome?
✓ Correct answer: (C)
This is the canonical Unit 5 long-run story. Expansionary fiscal policy shifts AD right. In the short run, real GDP rises, unemployment dips below NRU, and inflation rises (movement along SRPC₀ from point A to point B). But workers eventually observe the higher inflation and adjust their expectations. They demand higher nominal wages to maintain real wages. Firms face higher costs, cut back on hiring, and unemployment drifts back to the NRU. The SRPC has shifted up to SRPC₁ to reflect the new expected inflation. The end result: unemployment is back at the NRU (we land on the vertical LRPC), but inflation is permanently higher than it was at point A.
Why the other options miss the mark
- (A) Describes the short-run outcome, not the long-run outcome. The trade-off doesn't last.
- (B) Inflation rises, not falls, with expansionary fiscal policy. The direction is backward.
- (D) Inflation does not return to original levels in the long run. It is permanently elevated.
- (E) Unemployment doesn't rise above NRU from expansionary policy. This describes a contractionary scenario, with the wrong inflation direction.
🔗 Review: Walk through the "A → B → C" mnemonic. A: starting point at NRU. B: short-run boom, unemployment below NRU. C: long-run catch-up, back at NRU with permanently higher inflation.
3. A country's economy experiences both rising inflation and rising unemployment in the same period. Which of the following best explains this observation?
✓ Correct answer: (D)
The observation — inflation and unemployment moving in the same direction (both rising) — is the textbook signature of stagflation. The standard inverse relationship on the SRPC says inflation and unemployment should move in opposite directions when only AD changes. If we see them rising together, the SRPC itself must have shifted to a worse position. A negative supply shock (oil price spike, supply chain disruption, natural disaster) does exactly this: it raises production costs, which raises prices (↑ inflation), and forces firms to cut production, which raises unemployment.
Why the other options miss the mark
- (A) An AD increase would lower unemployment, not raise it. AD shifts cannot produce same-direction movement of inflation and unemployment.
- (B) A Fed bond purchase is expansionary monetary policy → AD shifts right → lower unemployment. Doesn't match the data.
- (C) A leftward LRPC shift would lower the NRU. With inflation expectations stable, this would reduce both inflation and unemployment, not increase them.
- (E) Lower expected inflation shifts the SRPC down, lowering inflation at any unemployment rate. Wrong direction for both variables.
🔗 Review: Re-read "Stagflation: When the Trade-Off Breaks." The pattern to memorize: inflation and unemployment in the same direction = supply shock or expectations shift, never an AD shift.
4. Which of the following changes would shift the long-run Phillips Curve (LRPC) to the LEFT?
✓ Correct answer: (E)
The LRPC is vertical at the Natural Rate of Unemployment (NRU). The only way to shift the LRPC is to change the NRU itself, and the NRU is determined entirely by structural labor-market factors. Better online job-matching platforms reduce frictional unemployment (the time workers spend searching for jobs). With less friction, the NRU falls, and the LRPC shifts left to a lower unemployment rate. This is a real, important phenomenon — the rise of LinkedIn, Indeed, and other platforms is one reason economists believe the modern NRU is lower than it was in the 1970s.
Why the other options miss the mark
- (A) An increase in the money supply is monetary policy. It shifts AD and (eventually) the SRPC, but not the LRPC.
- (B) Higher expected inflation shifts the SRPC up, not the LRPC. The NRU doesn't move with expectations.
- (C) Government spending is fiscal policy. It shifts AD, but not the LRPC. The NRU is structural.
- (D) A positive AD shock causes movement along the SRPC (lower unemployment short-run), but the LRPC doesn't shift.
🔗 Review: Re-read "Shifters of the LRPC." Memorize: only changes to structural labor-market features (job matching, training, demographics, regulations) shift the LRPC. Demand-side policies cannot.
5. Which of the following best describes the relationship between the AD-AS model and the Phillips Curve?
✓ Correct answer: (A)
The two models are two views of the same underlying story. The AD-AS model graphs price level vs. real GDP; the Phillips Curve graphs inflation rate vs. unemployment rate. Inflation is the rate of change of the price level, and unemployment is inversely related to output. The long-run pinning point in the AD-AS model is the LRAS, which is vertical at full-employment output (Yf). The long-run pinning point in the Phillips Curve model is the LRPC, vertical at the Natural Rate of Unemployment (NRU). At Yf, by definition, unemployment equals the NRU — so these two vertical lines describe the same economic state from different angles.
Why the other options miss the mark
- (B) Both models agree: there's no long-run trade-off between output/unemployment and the price level/inflation. They're consistent, not contradictory.
- (C) Both models apply equally to both kinds of policy. There's no division of labor between them.
- (D) The SRPC slopes downward because of the short-run trade-off between unemployment and inflation, which comes from sticky wages and prices — the same mechanism that makes SRAS slope upward. LRAS being vertical doesn't explain why SRPC slopes downward; the two are separate (parallel) features of their respective models.
- (E) The Phillips Curve is closely linked to the AD-AS framework — they're two views of the same model, not independent.
🔗 Review: Re-read "The AD-AS ↔ Phillips Curve Mirror." Internalize the equivalence: Yf in AD-AS = NRU in Phillips Curve. This single insight unlocks every dual-graph FRQ in Unit 5.
Ready for more? Take the full Unit 5 Practice Test →
End of Section 5.1. Up next: 5.2 Fiscal & Monetary Policy in the Long Run — where the Phillips Curve and AD-AS model team up to show why demand-side policies don't change long-run output.