Long Run Phillips Curve: Videos & Practice Problems

The long run Phillips curve represents the relationship between unemployment and inflation when the economy is operating at its potential GDP, meaning all resources are efficiently used. Unlike the short run Phillips curve, which shows a trade-off between inflation and unemployment, the long run Phillips curve is vertical at the natural rate of unemployment (around 4%). This means that in the long run, unemployment remains constant regardless of inflation fluctuations. The natural rate includes frictional and structural unemployment, reflecting people changing jobs or industries. In contrast, the short run Phillips curve can shift due to temporary changes in aggregate demand, causing unemployment and inflation to move inversely. The long run curve emphasizes that inflation does not affect unemployment once the economy reaches its potential output.

The natural rate of unemployment is the level of unemployment that exists when the economy is at potential GDP, typically around 4%. It includes frictional unemployment (people transitioning between jobs) and structural unemployment (mismatches between workers' skills and job requirements). This rate is important in the long run Phillips curve because it represents the unemployment rate that the economy cannot go below without causing inflation to accelerate. The long run Phillips curve is vertical at this natural rate, indicating that inflation changes do not affect unemployment in the long run. Understanding this helps explain why policies aimed at reducing unemployment below this natural rate may only lead to higher inflation without improving employment.

Along the long run Phillips curve, inflation can vary without affecting the unemployment rate, which remains fixed at the natural rate of unemployment. This means that even if inflation rises or falls, unemployment stays constant in the long run. The curve is vertical, showing no trade-off between inflation and unemployment over time. This contrasts with the short run Phillips curve, where inflation and unemployment have an inverse relationship. The long run perspective reflects that inflation expectations adjust, and the economy returns to its natural unemployment rate regardless of inflation changes.

Potential GDP is the level of output the economy can produce when all resources are fully and efficiently utilized. In the context of the long run Phillips curve, potential GDP represents the point where the economy operates at its natural rate of unemployment. The long run Phillips curve is vertical at this point, indicating that unemployment is fixed at the natural rate regardless of inflation. This means that while inflation can fluctuate, the economy's output and unemployment remain stable at potential GDP in the long run. Understanding potential GDP helps explain why unemployment cannot be permanently reduced below its natural rate without causing inflation to accelerate.

The non-accelerating inflation rate of unemployment (NAIRU) is the unemployment rate at which inflation remains stable, neither accelerating nor decelerating. It is closely related to the natural rate of unemployment and is often treated as the same in macroeconomic analysis. In the long run Phillips curve, NAIRU represents the vertical point where unemployment stays constant regardless of inflation changes. If unemployment falls below NAIRU, inflation tends to rise; if it rises above NAIRU, inflation tends to fall. The long run Phillips curve shows that in the long run, the economy gravitates toward this rate, emphasizing that attempts to push unemployment below NAIRU will only lead to accelerating inflation without long-term gains in employment.