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Week 12 · Lecture outline

Week 12 — Lecture Outline · Inflation, the Phillips Curve & Expectations

Principles of Macroeconomics · ECON 2 Fall 2026 · Prof. Ashford Fictional sample

Course: Principles of Macroeconomics (ECON 2) · Silver Oak University (fictional sample) · Prof. Ashford
Objective 8 — the Phillips curve, the quantity theory of money, and (starting next week) open-economy tools · SLO A & B
Meeting pattern: two 75-min sessions (≈150 min). Segment minutes below total ~150 — scale to your room.

The deck (E), the tutorial (C), and the workshop (P) all teach from this outline. Every number here is pre-computed and independently verified (see the verified box in §4 and §5; Python check: _build/logs/week-12-numbers.txt).

Week at a glance
Big question Is there really a trade-off between inflation and unemployment — and if so, does it last?
By week's end students can (1) read the short-run Phillips curve and locate two points on it; (2) explain why the long-run Phillips curve is vertical at the natural rate; (3) explain how expected inflation shifts the SRPC; (4) name and avoid THE CLASSIC ERROR (treating the tradeoff as permanent); (5) apply MV = PQ to compute the price level and demonstrate long-run monetary neutrality; (6) use the money-growth-minus-output-growth approximation for inflation, labeled as an approximation; (7) sort inflation/unemployment policy claims into positive vs. normative.
Key vocabulary short-run Phillips curve (SRPC), long-run Phillips curve (LRPC), natural rate of unemployment, expected inflation, adaptive expectations (named factually), quantity theory of money, equation of exchange (MV = PQ), velocity of money, long-run monetary neutrality, disinflation, stagflation (recall from Week 6)
Materials whiteboard; the Week-12 readings/links; Desmos or a spreadsheet for the quantity-theory table and the Phillips-curve plot; an approved chatbot
Timing note 8 segments ≈ 150 min across two sessions. Trim Segment 7 (interaction) if short on time.

Segment 1 — HOOK: "Would you take that deal?" (10 min)

Open with the thought experiment: "Imagine a policymaker could permanently trade 1 percentage point more inflation for 1 percentage point less unemployment — forever. Would you take that deal?" Let a few answers land — someone will say yes (lower unemployment sounds great), someone will worry about inflation eroding savings and fixed incomes. Then the reframe: "Here's the twist: for a few decades, this looked like a real, stable menu economists could point to. Today you'll learn why it isn't — and why believing it was is one of the most consequential mistakes in the history of macroeconomic policy."

Name the week's two tools up front: the Phillips curve (inflation vs. unemployment) and the quantity theory of money (MV = PQ) — two different lenses on the same underlying question: what determines the price level, and can policy permanently improve one macro outcome by tolerating a worse one in another?

Segment 2 — THE SHORT-RUN PHILLIPS CURVE (22 min)

Plain-language idea first: in the short run, when unemployment is lower, businesses are competing harder for workers and customers, wages and prices tend to rise faster — inflation tends to be higher. When unemployment is higher, that competitive pressure eases, and inflation tends to be lower. Graphed with the unemployment rate on the horizontal axis and the inflation rate on the vertical axis, this produces a curve that slopes down — the short-run Phillips curve (SRPC).

Name it factually: this pattern is named for A. W. Phillips, an economist who documented a historical relationship between unemployment and wage inflation. We use the idea factually here — a real, historically observed short-run pattern — without inventing any specific quote or study beyond what's named.

✅ VERIFIED NUMBERS (pre-computed; do not recompute live)

  • SRPC point 1: unemployment u = 4%, inflation π = 6%.
  • SRPC point 2: unemployment u = 6%, inflation π = 2%.
  • Moving from point 1 to point 2: unemployment rises (4% → 6%) while inflation falls (6% → 2%) — confirming the curve slopes down. This is the short-run trade-off: lower unemployment tends to come with higher inflation, and vice versa, along this one curve.

Say it in words (the SLO-A habit): "At 4% unemployment, this economy is running hot enough that inflation sits at 6%; cool it down to 6% unemployment, and inflation falls to 2%." Two points, one downward-sloping curve, describing one short-run relationship.

Segment 3 — THE LONG-RUN PHILLIPS CURVE, THE NATURAL RATE & THE CLASSIC ERROR (25 min)

Here's where the story gets its twist. If policymakers try to hold unemployment permanently below its "natural" level by keeping the economy running hot, workers and firms eventually expect the higher inflation and build it into wage and price decisions. When that happens, the short-run trade-off shifts — you don't get to keep the lower unemployment; you just end up with higher inflation and the same unemployment rate as before.

Name it factually: this argument is most associated with Milton Friedman and the natural-rate idea — the claim that in the long run, unemployment gravitates back to a "natural rate" determined by real, structural features of the labor market (frictional and structural unemployment — recall Week 3), regardless of the inflation rate. We name this idea factually, as a real and highly influential argument in the discipline's history, without inventing any specific quote.

✅ VERIFIED NUMBERS (pre-computed; do not recompute live)

  • LRPC: a vertical line at u* = 5% (the natural rate) — sitting exactly between the two SRPC points (4% and 6%) plotted above.
  • Read the vertical line correctly: at any inflation rate, in the long run unemployment returns to 5%. The LRPC has no slope in the u–π sense — it says inflation can be anything, but sustained unemployment below or above 5% cannot persist.
  • Expected inflation shifts the SRPC. If people come to expect higher inflation, the entire SRPC shifts up and to the right — the SAME unemployment rate now comes with higher inflation than before, because that expected inflation is now baked into wage and price-setting.

🚨 THE CLASSIC ERROR (name it explicitly, more than once): treating the SRPC's downward slope as if it were a permanent, exploitable long-run menu — as if a policymaker could pick any point on that one curve and stay there forever. It cannot. The short-run trade-off is real, but it is exactly that: short-run. Once expectations adjust, the curve itself shifts, and the "free lunch" disappears. Never let this course, or any exam question, imply the tradeoff is long-run — it is short-run only.

Read the two curves together (the graph-logic habit): the SRPC is one curve you can slide along in the short run; the LRPC is the vertical line that pins down where unemployment must return to once expectations catch up. An economy can sit at different points along a given SRPC temporarily, and can even see its SRPC shift if expected inflation changes — but it cannot sit at an unemployment rate away from 5% forever.

Segment 4 — WORKED EXAMPLE: THE QUANTITY THEORY OF MONEY, MV = PQ (28 min)

Set it up on the board and do every step out loud.

Now the second tool: the quantity theory of money, built from the equation of exchange:

M × V = P × Q
where M = the money supply, V = the velocity of money (how many times, on average, each dollar changes hands in a year), P = the price level, and Q = real output (real GDP).

Step 1 — find the price level. Suppose M = 500 and V = 4.
- M × V = 500 × 4 = 2,000. This is total nominal spending in the economy.
- Suppose real output Q = 1,000. Since M × V = P × Q, then P = (M × V) / Q = 2,000 / 1,000 = 2.

Step 2 — grow the money supply by 10% and hold V and Q fixed.
- New M = 500 × 1.10 = 550.
- New M × V = 550 × 4 = 2,200.
- New P = 2,200 / 1,000 = 2.2.
- The money supply rose 10%, and the price level rose from 2 to 2.2 — also exactly 10%.

Say it in words (this is long-run monetary neutrality): "When velocity and real output don't change, a 10% increase in the money supply produces a 10% increase in the price level — nothing more, nothing less. Real output (Q) is untouched in the long run; only the price level moves." This is long-run monetary neutrality — money is "neutral" with respect to real variables in the long run, even though (recall Weeks 10–11) it very much matters for real variables like output and employment in the short run.

A useful approximation (label it clearly as an approximation): economists often summarize the long-run relationship as inflation ≈ money growth − output growth. Example: if the money supply grows 8% a year and real output grows 3% a year, then inflation ≈ 8% − 3% = 5%. Say this explicitly: this is a rule-of-thumb approximation, not an exact law — it holds cleanly when velocity is roughly stable, and real-world velocity does shift over time.

Segment 5 — CONNECTING THE TWO TOOLS + NAMED MISCONCEPTIONS & CURES (18 min)

How MV = PQ and the Phillips curve fit together: the quantity theory explains why, in the long run, persistently high inflation is fundamentally a monetary phenomenon — sustained rapid money growth relative to output growth. The Phillips curve explains how the economy gets from "low inflation" to "high inflation" along the way: in the short run, an overheating economy (unemployment below the natural rate) produces rising inflation; but if the central bank keeps growing the money supply to keep unemployment low, that inflation becomes expected, the SRPC shifts, and the economy ends up back at the natural rate of unemployment — just with permanently higher inflation. Both tools point to the same conclusion: there is no permanent, free trade-off.

Named misconceptions + cures:
- "The Phillips curve shows the trade-off is a bad model." No — the SRPC is a real short-run pattern; the error is extending it to the long run (THE CLASSIC ERROR, restated).
- "MV = PQ says money doesn't matter." No — it says money is neutral for real output specifically in the long run; Weeks 10–11 already showed money very much moves real output in the short run via the transmission mechanism.
- "Velocity is just a made-up number to make the equation balance." No — V has real meaning (how fast money circulates); the model's clean, teaching-friendly version often treats V as roughly stable, which is a simplification worth naming.

Segment 6 — TECHNOLOGY WORKFLOW + AI-CRITIQUE (18 min)

Live demo (Desmos or spreadsheet): build a small quantity-theory table (M, V, Q, P) and recompute P after a money-supply increase; separately, plot the two SRPC points (4, 6) and (6, 2) and the vertical LRPC line at u = 5 on the same axes.

AI-critique moment (do this with the class): Ask an approved chatbot: "If the money supply is 500, velocity is 4, and real output is 1,000, what is the price level? If the money supply then rises 10%, what happens to the price level and to real output in the long run? Also, does the Phillips curve show a permanent trade-off between inflation and unemployment?" Then audit it together: the right answers are P = 2, rising to P = 2.2 (a 10% increase, matching the 10% money growth) with real output unchanged in the long run, and NO — the Phillips-curve trade-off is short-run only; the long-run curve is vertical at the natural rate. Chatbots frequently mix up which variable changes (claiming real output rises with the money supply in the long run — that's the short-run story, not the long-run one), or wave through the Phillips-curve trade-off as permanent without the short-run/long-run distinction. Make the class catch the error and state the correct reasoning. The habit all term: the tool drafts, you judge.

Segment 7 — INTERACTION: mini-debate (14 min)

Pose the discussion's driving question in miniature: "If a central bank must occasionally err on one side, should it lean toward tolerating slightly more inflation, or slightly more unemployment?" Split the room into two sides for a 2-minute prepared mini-debate, then a whole-class debrief. Instructor framing (say this explicitly before starting): "There's a real, evenhanded debate here about which cost society should be more willing to bear — that's a normative question. But nobody in this debate gets to argue that we can permanently have both low inflation AND low unemployment forever by picking the 'right' point on the SRPC — that's the error we just spent an hour ruling out." This previews Discussion 12 directly.

Segment 8 — CALLBACKS, TEASE & THE WEEK'S WORK (15 min)

  • Callback: every idea today pointed at the same conclusion — the Phillips curve's downward slope is a genuine short-run pattern, but it is not a permanent menu; the quantity theory explains why sustained inflation is, in the long run, a monetary phenomenon.
  • Tease next week: "So far this course has mostly stayed inside one country's borders. Next week we open the economy up: comparative advantage, the gains from trade, and why a 'trade deficit' isn't automatically a country 'losing.'"
  • The week's work: Lecture Tutorial (SRPC → LRPC → THE CLASSIC ERROR → MV = PQ → the approximation), Practice (6 reps), Quiz 12, Discussion 12, Assignment 12, and Workshop 12 ("MV = PQ & the Phillips Curve" — build the quantity-theory table and plot both curves in Desmos).

Instructor FAQ — common stumbles

  • "So is the Phillips-curve trade-off real, or not?" Both are true at once, at different time horizons: it's a real short-run pattern (the SRPC genuinely slopes down) but not a permanent long-run menu (the LRPC is vertical). Confusing the two horizons is THE CLASSIC ERROR.
  • "Why does the LRPC have to be exactly vertical — couldn't it just be steep?" The natural-rate argument says unemployment settles at a rate determined by real labor-market features (frictional/structural factors), independent of the inflation rate once expectations fully adjust — that independence is exactly what "vertical" means graphically. It's a strong theoretical claim, taught here factually as the discipline's dominant view, not derived from first principles in a principles course.
  • "If M goes up 10% and P goes up 10%, didn't the extra money just vanish into thin air?" No — it went into higher prices for the same real quantity of goods and services; nothing "vanished," but nothing real grew either. That's exactly what "neutral" means.
  • "Is 'inflation ≈ money growth − output growth' always exactly right?" No — it's an approximation that assumes velocity is roughly stable; real-world velocity does shift, so treat this as a rule of thumb, not an exact formula (unlike MV = PQ itself, which is an identity).
  • "Doesn't 'expected inflation shifts the SRPC' mean the whole model is unpredictable?" No — it means the SRPC is a snapshot that holds only while expectations stay fixed; once people revise their expectations, you get a new SRPC. The LRPC is what stays fixed (at the natural rate) across all of those short-run snapshots.

~ Prof. Ashford's edition · Fall 2026 · built with thecoursemaker.com