Answer to Question #227444 in Macroeconomics for Sima

Question

1)    How the Phillips Curve is related to the model of Aggregate Demand and Aggregate Supply. Explain using appropriate diagrams.

Answer 1

How the model of Aggregate Demand and Aggregate Supply is related to the Phillips curve in the long run.

The Aggregate demand and Aggregate supply model shows the short run relationship between price level and employment. As price level rises, employment increases( that is point A to point B on the aggregate supply curve in the diagram below.

The Phillips curve shows the short run relationship between inflation and unemployment. As price level rises, the level of unemployment decreases for point A to B on the Phillips curve.

How the model of Aggregate Demand and Aggregate Supply is related to the Phillips curve in the long run.

An increase in the supply of money results in an increase in aggregate demand and price levels thereby rising inflation rate. In this case, output and unemployment stay at their natural states.

Change in prices move up or down a vertical long run aggregate supply curve and the long run Phillips curve. But this does not affect the natural rate of output or unemployment.