let's talk a little bit about the short run and long run phillips curve now they're named after the economist bill phillips who saw in the 1950s what looked like an inverse relationship between inflation and the unemployment rate and he was studying decades of data sets in the united kingdom where he saw usually when we had high or when the united kingdom had high inflation you had relatively low unemployment and that tended to be when the economy was doing well so he would see these data points from different years and then he would see that when there was a high unemployment rate when the economy was a little bit slower then you had low inflation and so he theorized the existence of a curve that could describe this relationship maybe it looks something like this and if we take this model or if we assume this model then it would hold that when the economy is strong you have high inflation low unemployment when the economy is weak you have high unemployment and low inflation now you fast forward to the 1970s and economists started to see a situation where this broke down in the 1970s in particular you saw situations of stagflation where you had both high unemployment and high inflation so it didn't seem to fit the phillips curve and so economists theorized that okay maybe this thing that phillips theorized is really just what happens in the short run so they said that this is the short run phillips curve but they theorize that there's actually a long run phillips curve as well that describes the natural rate of unemployment or the natural rate of unemployment you would get when the economy is at full employment and remember full employment doesn't mean everyone's employed it just means the sustainable rate of employment for the country and so if we wanted to draw that long run phillips curve that economists theorized in the 1970s it might look something like this and when you see it as a vertical line like this let me write this long run phillips curve it shows that over the long run the unemployment rate would be this value right over here irrespective of what's going on with inflation and so let's say for this economy our natural rate of unemployment is 4 and we see that it is associated with one percent inflation and so you could imagine if there are some perturbations to the economy maybe the economy gets a little bit overheated well then you could get a little bit higher inflation and lower unemployment or if the economy slows down a little bit you could have higher unemployment and lower inflation but it should gravitate back to the long run phillips curve but now let's think about this in context of our aggregate demand aggregate supply model and think about a scenario where our short run phillips curve could actually shift so here we have our typical axes when we're thinking about aggregate demand and aggregate supply we have real gdp on our horizontal axis the price level on our vertical axis and so our aggregate demand curve might look something like this it is downward sloping so let's call that our aggregate demand curve and then our short run aggregate supply curve might look something like this so as price levels go up in the short run people are going willing to produce more so this is our short run aggregate supply and remember when we talked about aggregate demand and aggregate supply we talked about a notion of our full employment output which is you could view as the sustainable rate of output for an economy and we can draw that as a vertical line so this right over here would be our long run aggregate supply and where it intersects our real gdp axis this is our full employment output if you want to put some numbers on it maybe this is equal to for a small economy maybe this is equal to 50 billion dollars so the way we've just described this we are at equilibrium right now we're at full employment output our economy is producing 50 billion dollars per year and our full employment output implies an unemployment rate of four percent where we have one percent inflation now let's say that there's some type of a demand shock let's say all of a sudden the government wants to stimulate the economy even beyond where it is here and so you have a and so they start spending all of this money and so you have a shift in the aggregate demand curve so it would shift to the right so the aggregate demand curve would now look something like this let's call that aggregate demand 2. well what happens now and we've seen this in previous videos now you have we go from this equilibrium point which was at this full employment output and at this price level let's call that price level one and now we're at this equilibrium point people are demanding more so suppliers say hey if you want me to produce more i'm going to charge you some more for it too so our price level has gone up we are at price level 2 and we are producing above full employment output maybe this level right here is 60 billion well how would that be reflected on our phillips curves well in the short run our economy has gotten a little bit above potential so in the short run so we would sit on the short run phillips curve and our unemployment rate would go down but if we assume the phillips curve the short run phillips curve model that means our inflation would go up so this point right over here might correspond maybe to this point right over there where when we get to that beyond full employment output let's say that this is 60 billion right over here well maybe our unemployment rate is 2 and our inflation rate here is three percent now what happens next well we've talked about this when we studied aggregate demand and aggregate supply workers when it's time for them to renegotiate their contracts will say hey prices have gone up i'm not going willing to work for the same amounts over the long run and so you have a shift to the left of the aggregate supply curve at any given price level there's going to be less supply less output and so if this shifts to the left eventually the equilibrium point will go back to where everything intersects with the long run aggregate supply curve so the short run aggregate supply curve shifts over there and then we would be back to our full employment output although our price level would have gone even higher price level three now many economists would argue that when you have a shift in the short run aggregate supply so this would be short run aggregate supply 2 that that also is associated with a shift in our short run phillips curve because of these price increases and because workers have are trying to renegotiate their salaries upwards and labor is the biggest factor in price levels you might have increased inflation expectations so in a given rate of inflation you would you might start having a higher unemployment and so this short run phillips curve could shift to the right so instead of this just gravitating back to where it was before the whole curve could shift to the right and we get to a situation that looks like this where our inflation is still at three percent but we are back to the long run unemployment rate of this economy