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A-Level Economics · Short-run Phillips curve diagram question

The central bank raises interest rates to bring inflation down. What does this diagram say it costs?

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The diagram

The answer

Lower inflation, but higher unemployment — a movement from A towards B. Coming down the curve you buy lower inflation with higher unemployment. How bad the trade-off is depends on where you are: with a lot of spare capacity it is brutal, with little spare capacity you can cut inflation cheaply. Contractionary monetary policy cuts AD: inflation falls, but growth falls and unemployment rises with it — a movement from A towards B. Naming the trade-off, and then judging how severe it is given spare capacity, is where the evaluation marks sit.

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This is one of 5 questions on the short-run phillips curve diagram — every corner lettered, every wrong answer diagnosed.

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