In the second lesson on the Phillips Curve model we will further explore the relationship between unemployment and inflation in an economy, this time examining what happens in the long-run, or the flexible-wage period, following a change in aggregate demand in an economy. Will the tradeoff between inflation and unemployment exist even once wages and prices have had time to adjust to the level of demand for a nation’s output?
We will find that, in fact, as an economy self-corrects from changes to aggregate demand and output returns to its full employment level, the unemployment rate will always return to its natural rate, even as inflation rises and falls with demand in the economy.