Answer to Question #227510 in Macroeconomics for Gagani

Question

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

Answer 1

The Aggregate Demand and Supply Model depicts the short-run relationship between price level and employment. As the price level rises, employment rises (as shown in the diagram below, from point A to point B on the aggregate supply curve).

The Phillips curve depicts the relationship between inflation and unemployment in the short run. For point A t, as the price level rises, the level of unemployment decreases.

An increase in the supply of money leads to an increase in aggregate demand and price levels, resulting in an increase in the inflation rate. In this case, output and unemployment remain at their pre-crisis levels.

Price changes move a vertical long run aggregate supply curve and the long run Phillips curve up or down. However, this has no effect on the natural rate of output or unemployment.