Inflation, Unemployment and the Phillips Curve (A Level Economics)

The Phillips curve (A Level Economics) joins two macro objectives that pull against each other: low inflation and low unemployment. Push unemployment down with extra demand and inflation rises. Squeeze inflation and unemployment rises. That is the short-run trade-off. The long-run version says the trade-off disappears once people expect the inflation. This page covers how inflation and unemployment are measured, their causes, the types of unemployment and the policy for each, both Phillips curve diagrams, a CPI worked example and three exam-style questions with the answers derived.

Spec map: where inflation, unemployment and the Phillips curve sit on your board

Section numbers are from the AQA specification (the PDF numbers these sections 4.2.3.x, the web version 3.2.3.x), the Edexcel specification (Issue 2), the OCR specification (v3.0, June 2026) and the Cambridge syllabus for 2026 to 2028, all checked in September 2026. Edexcel names only the short-run curve; the other three want the long-run one too. The AD/AS diagram that sits behind all of this is on the aggregate demand and aggregate supply page.

What you must be able to do

• Define inflation, deflation and disinflation, and calculate the inflation rate from index numbers.
• Explain how the CPI is built and why it differs from the RPI.
• Explain demand-pull and cost-push inflation, each with an AD/AS diagram.
• Name the types of unemployment, give the cause of each and the policy that fits it.
• Draw the short-run Phillips curve and explain the trade-off it shows.
• Draw the long-run Phillips curve, explain why it is vertical and what the natural rate is.
• Evaluate whether policymakers can use the trade-off.

Measuring inflation: the CPI and the RPI

Inflation is a sustained rise in the general price level. The Office for National Statistics measures it with the Consumer Prices Index. Statisticians price a basket of goods and services each month, weight each item by its share of household spending, and turn the total into an index. The inflation rate is the percentage change in the index over twelve months.

Causes of inflation: demand-pull and cost-push

Edexcel also lists growth of the money supply as a cause: too much money chasing too few goods, the monetarist view summed up in MV = PQ. Expectations matter for both types. If workers expect 4% inflation they ask for 4% pay rises, and firms who expect it raise prices in advance. Expected inflation becomes actual inflation, which is the key to the long-run Phillips curve.

Unemployment: measures and types

The UK has two measures. The claimant count is the number claiming unemployment-related benefits: cheap and monthly, but it misses people who do not claim. The Labour Force Survey uses the International Labour Organisation definition: without a job, available to start within two weeks, and actively looking. It is the official rate. Under-employment, people working fewer hours than they want, appears in neither.

The natural rate of unemployment is the unemployment left when the economy is at full employment: the frictional and structural parts. It is where the long-run Phillips curve stands. OCR’s NAIRU, the non-accelerating inflation rate of unemployment, is the same idea named for what happens if you push below it.

The short-run Phillips curve: the trade-off

Plot inflation against unemployment and the short-run curve slopes down. Lower unemployment goes with higher inflation. The reason is the AD/AS diagram turned sideways: a demand boost raises output and cuts unemployment, but it also raises the price level. The curve is convex. The closer the economy gets to full employment, the more inflation each extra job costs.

At A unemployment is 5% and inflation 2%. Boost demand and the economy climbs to B: unemployment 2.5%, inflation 4%. Let demand fall and it slides to D: unemployment 8%, inflation 1.25%. Note the shape. The first percentage point off unemployment (5% to 4%) costs half a point of inflation. The next one and a half (4% to 2.5%) cost one and a half points.

The long-run Phillips curve: expectations and the natural rate

The trade-off in figure 1 works only while people are surprised by the inflation. Once workers and firms expect 4% inflation, they build it into wage claims and prices. Real wages fall back to where they were, the extra jobs disappear, and unemployment returns to its natural rate. The economy is back at 5% unemployment, but now with 4% inflation. The short-run curve has shifted up.

Join the long-run points A and C and you get a vertical line at the natural rate. That is the long-run Phillips curve, the expectations-augmented version, AQA’s “L-shaped” curve. Its message: there is no long-run trade-off. Demand management can only pick the inflation rate at which the economy sits at its natural rate. To get unemployment down for good, you have to move the natural rate itself, with supply-side policy that cuts frictional and structural unemployment.

Worked example — building a price index and reading the inflation rate

A small economy’s basket has three groups. Food takes 30% of spending, housing 40% and transport 30%. Prices are indexed so that each group is 100 in year 1.

1. Year 2 prices: food up 6% (index 106), housing up 4% (104), transport up 2% (102).
2. Weight them: CPI = 0.3 × 106 + 0.4 × 104 + 0.3 × 102 = 31.8 + 41.6 + 30.6 = 104.0.
3. Inflation in year 2 = (104.0 − 100) ÷ 100 = 4.0%. Housing has the biggest weight, so its 4% rise counts most.
4. Year 3 prices: food 110, housing 108, transport 105. CPI = 33.0 + 43.2 + 31.5 = 107.7.
5. Inflation in year 3 = (107.7 − 104.0) ÷ 104.0 = 3.6% (to one decimal place). Prices are still rising; the rate has fallen. That is disinflation.
6. A worker’s pay rose 3% in year 2. Real pay changed by roughly 3% − 4% = −1%. The exact figure is 1.03 ÷ 1.04 − 1 = −0.96%. A pay rise below inflation is a real pay cut.
7. Link to the Phillips curve: if this economy sat at A on figure 1 and inflation rose to 4%, unemployment had fallen towards 2.5%, point B. If the 4% came from energy prices instead, the curve itself shifted up: cost-push moves the curve, demand-pull moves along it.

Exam-style questions

Q1: The consumer prices index rises from 130.0 to 135.2 over a year. Calculate the rate of inflation and explain one limitation of the CPI as a measure of the cost of living for a pensioner. (4 marks)
A: Inflation = (135.2 − 130.0) ÷ 130.0 × 100 (1) = 4.0% (1). The CPI basket and weights are those of an average household (1). A pensioner spends a larger share on heating and food and nothing on commuting, so a rise in energy prices raises their cost of living by more than the CPI shows (1).

Q2: Using the short-run Phillips curve in figure 1, describe what happens to inflation as unemployment falls from 5% to 4%, and then from 4% to 2.5%. Explain what the long-run Phillips curve predicts if the government holds unemployment at 2.5%. (6 marks)
A: From 5% to 4% unemployment, inflation rises from 2% to 2.5%, half a percentage point (1). From 4% to 2.5%, inflation rises from 2.5% to 4%, one and a half points: the curve is convex, so each extra cut in unemployment costs more inflation (1). Holding unemployment below the natural rate of 5% needs a bigger demand boost every time (1). Once workers expect 4% inflation the short-run curve shifts up and unemployment returns to 5% at 4% inflation, point C on figure 2 (1). Holding it at 2.5% again would shift the curve up again, to 6% inflation at the natural rate (1). The long-run curve is vertical: the government gets accelerating inflation and no lasting fall in unemployment (1).

Q3: Evaluate the view that there is no trade-off between inflation and unemployment. (25 marks)
A: Two points for, two against, and end on a supported judgement.

• For the view: the long-run Phillips curve. Once expectations adjust, the economy returns to the natural rate whatever the inflation rate (A to B to C in figure 2). Trying to hold unemployment below the natural rate gives accelerating inflation. Only supply-side policy moves the natural rate.
• Against the view: the short-run curve. Over a year or two a demand boost does cut unemployment (5% to 2.5% in figure 1) at the cost of higher inflation, and the reverse: squeezing inflation from 4% to 2% raises unemployment. Policymakers live in the short run and face the trade-off at every decision.
• Evaluation: it depends on the time period, on how fast expectations adjust (a credible 2% target anchors them, which flattens the short-run curve), on where the economy starts (a negative output gap gives a cheap fall in unemployment), and on the cause of the inflation (cost-push shifts the curve rather than moving along it).
• Judgement: the trade-off exists in the short run and vanishes in the long run. “No trade-off” is the long-run truth and the short-run mistake.

Examiner’s checklist: the mistakes that lose Phillips curve marks

• Deflation for disinflation. Falling inflation with prices still rising is disinflation. Only a negative rate is deflation.
• The inflation rate calculated from the wrong base. Divide the change by the earlier index, not the later one.
• Axes swapped or unlabelled. Inflation on the vertical, unemployment on the horizontal, both in %.
• A shift when it should be a movement. Demand changes move the economy along the short-run curve. Changed expectations or a cost shock shift it.
• A long-run curve with no natural rate. Label the vertical line with the natural rate and say what it is made of: frictional plus structural unemployment.
• One-sided evaluation. Every trade-off question needs the short run on one side, the long run on the other, and a judgement about the time period.

Key takeaways

• Inflation is measured by the CPI: a weighted basket turned into an index. RPI includes housing costs and runs higher.
• Demand-pull inflation is AD shifting right; cost-push is SRAS shifting left. Expectations feed both.
• Unemployment is frictional, structural, cyclical, seasonal or real-wage. Match the policy to the type.
• The short-run Phillips curve slopes down and is convex: lower unemployment costs rising amounts of inflation.
• The long-run Phillips curve is vertical at the natural rate: no trade-off once expectations catch up.
• To cut unemployment for good, cut the natural rate with supply-side policy.

FAQ

Q: What is the Phillips curve in A Level Economics?
A: A diagram showing the relationship between inflation and unemployment. The short-run curve slopes down: lower unemployment goes with higher inflation. The long-run curve is vertical at the natural rate of unemployment, because once people expect the inflation the extra jobs disappear. Figures 1 and 2 are the two versions.

Q: How is inflation measured at A Level Economics?
A: By the Consumer Prices Index. A basket of goods and services is priced every month, each item weighted by its share of household spending, and the inflation rate is the percentage change in the index over a year. The worked example above builds one from three groups.

Q: What are the types of unemployment at A Level?
A: Frictional (between jobs), structural (skills or location no longer match the jobs), cyclical or demand-deficient (a negative output gap), seasonal and real-wage. Cambridge adds technological. The table above gives the cause and the policy for each.

Q: What is the difference between demand-pull and cost-push inflation?
A: Demand-pull inflation comes from aggregate demand rising faster than supply: AD shifts right and output rises with prices. Cost-push comes from higher costs of production: SRAS shifts left and output falls as prices rise. The 2022 UK spike was mainly cost-push, driven by energy prices.

Q: Why is the long-run Phillips curve vertical?
A: Because the short-run trade-off relies on workers being surprised by inflation. Once they expect it, they demand matching pay rises, real wages return to where they were, and unemployment goes back to the natural rate. Every attempt to hold unemployment below that rate just adds to inflation.

Q: Which questions come up on inflation, unemployment and the Phillips curve?
A: An inflation-rate calculation from index numbers for 2 to 4 marks, “explain, using a diagram, the short-run trade-off” for 4 to 8 marks, and a 15 or 25-mark evaluation of whether the objectives conflict. Paper detail is on the AQA, Edexcel and OCR pages; both Phillips curve diagrams are on the A Level economics diagrams page, and the revision hub lists the rest of the macro topics.

Make the trade-off earn its marks

If disinflation still comes out as deflation, or the long-run curve turns up without a natural rate, one lesson fixes that. Send your board, your year and the paper date, and a first lesson time will be with you inside a day. Pricing is on the A Level economics tutor page.