## Learning Outcomes

- Understand how to locate recessionary gaps, inflationary gaps, and long-run equilibrium on the Phillips Curve
- Identify why the long-run Phillips curve is vertical at the natural rate of unemployment
- Explain how gap positions on the Phillips Curve connect to the AD-AS model
- Distinguish between movement along the short-run Phillips curve and shifts of the short-run Phillips curve
- Infer whether actual inflation is greater than, less than, or equal to expected inflation from unemployment data
- Explain short-run and long-run adjustment from both recessionary and inflationary gaps

## AP Macroeconomics Syllabus

For the AP Macroeconomics, you are expected to understand gap positions around long-run equilibrium on the Phillips Curve, with a focus on the following syllabus points:

- Know that the **short-run Phillips curve (SRPC)** is downward sloping and the **long-run Phillips curve (LRPC)** is vertical
- Identify that the LRPC is located at the **natural rate of unemployment**
- Explain that a **recessionary gap** means unemployment is above the natural rate and the economy is to the right of the LRPC
- Explain that an **inflationary gap** means unemployment is below the natural rate and the economy is to the left of the LRPC
- Understand that long-run equilibrium occurs where unemployment equals the natural rate and actual inflation equals expected inflation
- Distinguish between a movement along the SRPC caused by aggregate demand changes and a shift of the SRPC caused by expected inflation or supply shocks
- Translate correctly between AD-AS and Phillips Curve graphs: right of LRAS in AD-AS corresponds to left of LRPC on the Phillips Curve
- Recognise that supply shocks can shift the SRPC and create stagflation

## Test Your Knowledge

_Attempt these questions before reading this article. If you find some difficult or cannot remember the answers, look more closely at that area during your revision._

1. What does a point to the right of the long-run Phillips curve represent?
2. How is an inflationary gap shown differently on an AD-AS graph and on a Phillips Curve graph?
3. When unemployment equals the natural rate of unemployment, what is true about actual and expected inflation?
4. What is the difference between moving along the SRPC and shifting the SRPC?
5. Why is the long-run Phillips curve vertical?

## Introduction

The Phillips Curve is one of the most tested graph ideas in AP Macroeconomics because it links inflation, unemployment, and macroeconomic adjustment. Students often remember that the short-run curve slopes downward, but lose marks when they have to place the economy relative to long-run equilibrium or switch between a Phillips Curve graph and an AD-AS graph.

This subtopic is really about using the Phillips Curve as a map. You need to know where long-run equilibrium sits, what it means to be to the left or right of that point, and how the economy returns to long-run equilibrium over time. If you can read the graph precisely, many MCQs and FRQs become much easier.

> **Key Term: Phillips Curve**
> A graph showing the relationship between the inflation rate and the unemployment rate, with inflation on the vertical axis and unemployment on the horizontal axis.

### Long-run equilibrium on the Phillips Curve

The first idea to fix in your mind is that the **horizontal axis is unemployment**, not output. That one fact prevents a lot of mistakes.

The long-run Phillips curve is vertical because, in the long run, the economy returns to its **natural rate of unemployment** no matter what the inflation rate is. Policymakers may push unemployment below the natural rate for a short time with expansionary policy, but not forever. Workers and firms adjust expectations, wages change, and the economy moves back to the natural rate.

> **Key Term: long-run Phillips curve (LRPC)**
> A vertical Phillips Curve located at the natural rate of unemployment, showing that there is no permanent tradeoff between inflation and unemployment in the long run.
>
> **Key Term: natural rate of unemployment**
> The unemployment rate that exists at full employment; it includes frictional and structural unemployment, but not cyclical unemployment.

Long-run equilibrium on the Phillips Curve means three things at once:

- unemployment equals the natural rate
- cyclical unemployment equals zero
- actual inflation equals expected inflation

That last point matters a lot. If actual inflation is different from expected inflation, the economy is not at its long-run resting point yet.

> **Key Term: expected inflation**
> The inflation rate households, workers, and firms expect to occur in the future.

Why is actual inflation equal to expected inflation in long-run equilibrium? Because over time, workers bargain for wages and firms set prices based on what they expect inflation to be. If actual inflation has been persistently higher or lower, expectations adjust. Once expectations fully catch up, there is no reason for unemployment to stay above or below the natural rate.

A simple memory rule is:

- **On the LRPC** = full employment
- **On the LRPC** = no cyclical unemployment
- **On the LRPC** = actual inflation equals expected inflation
  > **Test Tip:** On AP questions, if you are told unemployment equals the natural rate, immediately conclude the economy is on the LRPC and in long-run equilibrium unless a supply shock is clearly being discussed.

### Recessionary gaps and inflationary gaps around long-run equilibrium

Gap positions are easiest if you compare actual unemployment with the natural rate.

If actual unemployment is **above** the natural rate, the economy has a **recessionary gap**. On the Phillips Curve, that means the point lies **to the right of the LRPC**. Output is below full-employment output, so cyclical unemployment is positive.

> **Key Term: recessionary gap**
> A situation in which actual output is below full-employment output and unemployment is above the natural rate.

If actual unemployment is **below** the natural rate, the economy has an **inflationary gap**. On the Phillips Curve, that means the point lies **to the left of the LRPC**. Output is above full-employment output, so the economy is temporarily producing beyond sustainable full-employment output.

> **Key Term: inflationary gap**
> A situation in which actual output is above full-employment output and unemployment is below the natural rate.

This is where many students mix up the Phillips Curve with AD-AS.

On an AD-AS graph:

- recessionary gap = output left of LRAS
- inflationary gap = output right of LRAS

On a Phillips Curve:

- recessionary gap = unemployment right of LRPC
- inflationary gap = unemployment left of LRPC

The direction flips because the x-axis changes from **output** to **unemployment**.

A strong way to think about it is this cause-and-effect chain:

- lower output means firms need fewer workers
- fewer workers means higher unemployment
- so a recessionary gap appears left of LRAS on AD-AS but right of LRPC on Phillips Curve

And the reverse:

- higher output means firms hire more workers
- more hiring means lower unemployment
- so an inflationary gap appears right of LRAS on AD-AS but left of LRPC on Phillips Curve

Here is the clean mapping you should memorise:

- **Left of LRPC** = unemployment below natural rate = inflationary gap
- **Right of LRPC** = unemployment above natural rate = recessionary gap
- **On LRPC** = unemployment at natural rate = long-run equilibrium

Now connect this to inflation expectations.

In a recessionary gap, inflation pressure is weak. Typically, actual inflation is **less than expected inflation**.

In an inflationary gap, inflation pressure is strong. Typically, actual inflation is **greater than expected inflation**.

Worked example:

Suppose the natural rate of unemployment is **5%**.

- If actual unemployment is **7%**, unemployment is above the natural rate by 2 percentage points. The economy has a recessionary gap and is to the right of the LRPC.
- If actual unemployment is **3%**, unemployment is below the natural rate by 2 percentage points. The economy has an inflationary gap and is to the left of the LRPC.
- If actual unemployment is **5%**, the economy is on the LRPC.

A second AP-style inference:

Suppose expected inflation is **3%** and unemployment is **6%** while the natural rate is **4%**.

Because unemployment is above the natural rate, the economy is in a recessionary gap. That means actual inflation is likely **below** expected inflation, so actual inflation is likely below **3%**.

> **Test Tip:** If a question gives you unemployment and the natural rate, compare those first. Do not start by guessing from the inflation number. The unemployment comparison tells you the gap position immediately.

### Movement along SRPC versus shifts of SRPC

Students often know the shapes of the curves but confuse what causes motion on them.

The **short-run Phillips curve** is downward sloping. That means, in the short run, lower unemployment is associated with higher inflation, and higher unemployment is associated with lower inflation.

> **Key Term: short-run Phillips curve (SRPC)**
> A downward-sloping Phillips Curve showing the short-run tradeoff between inflation and unemployment.

A **movement along** a given SRPC is caused by a change in **aggregate demand**. If AD rises, output rises, unemployment falls, and inflation rises. The economy moves **up and left** along the same SRPC. If AD falls, output falls, unemployment rises, and inflation falls. The economy moves **down and right** along the same SRPC.

This is the classic short-run tradeoff.

But a **shift of the SRPC** is different. It happens when **expected inflation changes** or when a **supply shock** hits the economy.

- higher expected inflation shifts SRPC **up/right**
- lower expected inflation shifts SRPC **down/left**

Why? Because if workers and firms expect more inflation, they build that into wage demands and price setting. For any unemployment rate, the inflation rate ends up higher.

> **Key Term: actual inflation**
> The inflation rate that actually occurs in the economy.

If expected inflation rises from 2% to 4%, then at the same unemployment rate the economy now has a higher actual inflation rate. That is not movement along the curve. It is a new curve.

A supply shock can also shift the SRPC. A negative supply shock, such as a sharp rise in oil prices, raises inflation and unemployment together. That shifts the SRPC up/right and creates **stagflation**.

> **Key Term: stagflation**
> A situation in which inflation and unemployment both rise, usually because of a negative supply shock.

This is why the simple tradeoff does not always hold. When aggregate demand changes, inflation and unemployment move in opposite directions along the SRPC. When aggregate supply changes, the SRPC itself shifts.

A side-by-side distinction:

- **AD change** -> movement along SRPC
- **Expected inflation change** -> shift of SRPC
- **Supply shock** -> shift of SRPC

A common error is saying "the Fed moved the Phillips Curve left" when describing expansionary policy. That is wrong if expected inflation has not changed. Expansionary policy first moves the economy **along** the SRPC toward lower unemployment and higher inflation.

### Self-correction back to long-run equilibrium

AP Macroeconomics often asks you to tell the long-run story, not just the short-run position.

Start with a recessionary gap. On the Phillips Curve, the economy is to the **right** of the LRPC. Unemployment is above the natural rate. Over time, weak labor demand puts downward pressure on nominal wage growth and inflation expectations. Expected inflation falls, so the SRPC shifts **down/left**. The economy returns to the LRPC at the natural rate of unemployment.

The key logic is:

1. recessionary gap means high cyclical unemployment
2. workers have less bargaining power
3. wage growth slows
4. expected inflation falls
5. SRPC shifts down/left
6. unemployment returns to the natural rate in long-run equilibrium

Now start with an inflationary gap. On the Phillips Curve, the economy is to the **left** of the LRPC. Unemployment is below the natural rate. Labor markets are tight, workers push for higher wages, and firms raise prices. Expected inflation rises, so the SRPC shifts **up/right**. Again, the economy returns to the LRPC.

That logic is:

1. inflationary gap means unemployment below natural rate
2. labor shortages push up wages
3. firms raise prices
4. expected inflation rises
5. SRPC shifts up/right
6. unemployment returns to the natural rate in long-run equilibrium

Notice what stays fixed in this long-run story: the **LRPC does not move** just because the economy self-corrects. The economy moves back to it as expectations change.

A brief numerical example:

Suppose natural unemployment is **5%**.

Initial short-run situation:

- unemployment = **7%**
- expected inflation = **3%**

This is a recessionary gap. Over time, expected inflation falls, perhaps from 3% to 2%, then to 1%, shifting SRPC down/left until unemployment returns to **5%**.

Or:

Initial short-run situation:

- unemployment = **3%**
- expected inflation = **2%**

This is an inflationary gap. Over time, expected inflation rises, perhaps to 4%, shifting SRPC up/right until unemployment returns to **5%**.

A final caution: full employment does **not** mean zero unemployment. It means unemployment equals the natural rate. Frictional and structural unemployment still exist. Only cyclical unemployment disappears at long-run equilibrium.

## Key Point Checklist

_This article has covered the following key knowledge points:_

- The Phillips Curve has inflation on the vertical axis and unemployment on the horizontal axis
- The short-run Phillips curve is downward sloping
- The long-run Phillips curve is vertical at the natural rate of unemployment
- Long-run equilibrium occurs where unemployment equals the natural rate
- At long-run equilibrium, cyclical unemployment is zero
- At long-run equilibrium, actual inflation equals expected inflation
- A recessionary gap means unemployment is above the natural rate and the economy is to the right of the LRPC
- An inflationary gap means unemployment is below the natural rate and the economy is to the left of the LRPC
- Aggregate demand changes cause movements along a given SRPC
- Changes in expected inflation shift the SRPC
- Negative supply shocks can shift the SRPC right and create stagflation
- On AD-AS, an inflationary gap is right of LRAS, but on the Phillips Curve it is left of LRPC

## Key Terms and Concepts

- Phillips Curve
- long-run Phillips curve (LRPC)
- natural rate of unemployment
- expected inflation
- recessionary gap
- inflationary gap
- short-run Phillips curve (SRPC)
- actual inflation
- stagflation


The Phillips Curve - Gap positions around long-run equilibrium