Question

Suppose that for years East Confetti’s short-run Phillips Curve was such that each 1 percentage point increase in its unemployment rate was associated with a 2 percentage point decline in its inflation rate. Then, during several recent years, the short-run pattern changed such that its inflation rate rose by 3 percentage points for every 1 percentage point drop in its unemployment rate. Graphically, did East Confetti’s Phillips Curve shift upward or did it shift downward? Explain.

Short answer

The following graph shows the upward shift in East Confetti’s Philips Curve.

The economy moved downwards along the Philips curve in the short run, causing a fall in the inflation rate and a rise in the unemployment rate. However, the Philips curve shifted upward in the long run, causing a rise in the inflation rate only while unemployment remained fixed at the natural rate.

Step-by-step solution

The illustration of Philips curve 

The Philips curve shows a tradeoff between unemployment and inflation rates.

The following figure depicts the relevant Philips curve.

The explanation for the graph 

In the short run, the economy moves from E₁ to E₂. Correspondingly, the unemployment rate increases by 1 percent, and the inflation rate declines by 2 percent.

In the long run, the economy moves from E₁ to E₃; correspondingly, the unemployment rate declines by 1 percent, and the inflation rate rises by 3 percent.

Hence, it can be inferred from the above figure that East Confetti’s Philips Curve has shifted upwards, due to which there has been a 3 percent rise in inflation rate and a 1 percent fall in the unemployment rate.