The extended AD-AS model and the Phillip's curve.

THE EXTENDED AS-AD MODEL In order to understand the effects of inflation in the long run, lets first analyze the long run aggregate demand (AD) and aggregate supply (AS) curves in the long run through the extended AS-AD model. SHORT-RUN AND LONG-RUN AGGREGATE SUPPLY Short Run It is the period in which nominal wages (and other input prices) remain fixed as the price level increases or decreases. Causes of fixed nominal wages: * Workers may not …

…beyond those consistent with full-employment output may temporarily boost profits, output, and employment. But nominal wages eventually will catch up so as to sustain real wages. When they do, profits will fall, negating the previous short-run stimulus to production and employment. Consequently, there is no tradeoff between the rates of inflation and unemployment in the long run, that is, the long-run Phillips Curve is roughly a vertical line of the economy's natural rate of unemployment.