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The Relationship Between the Phillips Curve and AD-AD
Changes in aggregate demand translate as movements along the Phillips curve.
If there is an increase in aggregate demand, such as what is experienced during demand-pull inflation, there will be an upward movement along the Phillips curve.
As aggregate demand increases, real GDP and price level increase, which lowers the unemployment rate and increases inflation.
The Phillips curve shows the inverse trade-off between rates of inflation and rates of unemployment.
If unemployment is high, inflation will be low; if unemployment is low, inflation will be high.
The Phillips curve and aggregate demand share similar components.
The Phillips curve is the relationship between inflation, which affects the price level aspect of aggregate demand, and unemployment, which is dependent on the real output portion of aggregate demand.
Consequently, it is not far-fetched to say that the Phillips curve and aggregate demand are actually closely related.
To see the connection more clearly, consider the example illustrated by .
Let's assume that aggregate supply, AS, is stationary, and that aggregate demand starts with the curve, AD1.
There is an initial equilibrium price level and real GDP output at point A. Now, imagine there are increases in aggregate demand, causing the curve to shift right to curves AD2 through AD4. As aggregate demand increases, unemployment decreases as more workers are hired, real GDP output increases, and the price level increases; this situation describes a demand-pull inflation scenario.
As more workers are hired, unemployment decreases. Moreover, the price level increases, leading to increases in inflation.
These two factors are captured as equivalent movements along the Phillips curve from points A to D.
At the initial equilibrium point A in the aggregate demand and supply graph, there is a corresponding inflation rate and unemployment rate represented by point A in the Phillips curve graph.
For every new equilibrium point (points B, C, and D) in the aggregate graph, there is a corresponding point in the Phillips curve.
This illustrates an important point: changes in aggregate demand cause movements along the Phillips curve.
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Source: Boundless. “The Relationship Between the Phillips Curve and AD-AD.” Boundless Economics. Boundless, 14 Nov. 2014. Retrieved 30 Apr. 2015 from https://www.boundless.com/economics/textbooks/boundless-economics-textbook/inflation-and-unemployment-23/the-relationship-between-inflation-and-unemployment-105/the-relationship-between-the-phillips-curve-and-ad-ad-400-12497/