OCR A Level Economics: The Phillips curve and schools of macroeconomic thought (H460) – Revision Notes

Quick recall for the Phillips Curve topic and the school-of-thought bullet in Component 2, Macroeconomics, of the OCR A Level Economics (H460) specification, Version 3.0 (June 2026), for first assessment in 2021. For full explanations and worked examples read the study guide, then test yourself with the practice questions. Course pages: the OCR Economics hub, the checklist, the Macroeconomics revision notes and the free diagnostics. All figures here are invented.

Key definitions

Term	Definition
Phillips Curve	Inverse relationship between unemployment and inflation (money wage growth)
Short-run Phillips Curve (SRPC)	Trade-off for a given level of expected inflation
Natural rate of unemployment	Unemployment left when the labour market clears: frictional plus structural, with no cyclical element
NAIRU	Non-accelerating inflation rate of unemployment: the rate at which inflation is stable
Adaptive expectations	Expected inflation is based on past inflation, e.g. this year’s expectation equals last year’s actual rate
Long-run Phillips Curve (LRPC)	Vertical line at the natural rate: no lasting trade-off
Cyclical unemployment	Actual unemployment minus the natural rate when it is positive
Malinvestment	Austrian term for investment misdirected by artificially cheap credit

The Phillips Curve in six lines

1. Axes: unemployment (%) horizontal; wage or price inflation (%) vertical.
2. Low unemployment means labour shortages, higher wage growth, higher costs and prices.
3. The curve slopes down and is convex; it is flatter at high unemployment.
4. Each SRPC is drawn for one level of expected inflation.
5. It cuts the vertical LRPC at the point where actual equals expected inflation.
6. A rise in expected inflation shifts the SRPC up.

Formulas and method

Result	Formula
Unemployment rate	unemployed ÷ labour force × 100
Expectations-augmented curve	inflation = expected inflation + b × (U* − U)
Adaptive expectations	expected inflation this year = actual inflation last year
Unit labour cost growth	(1 + w) ÷ (1 + p) − 1, with w = pay growth and p = output per worker growth
Cumulative growth over n years	(1 + g)ⁿ − 1
Unemployment needed for a target	U = U* − (target − expected) ÷ b

Method: adaptive-expectations table (the example below uses Country B, illustrative).

1. Write the equation and fix expected inflation for year 1.
2. Compute actual inflation for year 1.
3. Set next year’s expected inflation equal to this year’s actual.
4. Repeat. If U is below U*, inflation rises each year by b × (U* − U); if above, it falls by b × (U − U*).

Worked reminder. Country B: inflation = expected + 0.6 × (5 − U), starting at 3%.

• Hold U = 3.5%: gain each year 0.6 × 1.5 = 0.9. Inflation is 3.9%, 4.8%, 5.7% in years 1 to 3.
• Return U to 5%: inflation stays at 5.7%. No gain in jobs, higher inflation.
• Then hold U = 6.5% from 5.7%: inflation falls 0.6 × 1.5 = 0.9 a year, to 4.8%, 3.9%, 3.0%. Disinflation costs jobs.

Why unemployment is not tied to inflation in the long run. Workers and firms adjust expectations until actual equals expected inflation. That happens only at the natural rate.

Natural rate and NAIRU in one table

Actual U compared with natural rate	Labour market	Inflation
Below	Excess demand for labour	Higher than expected, so expectations rise and inflation accelerates
Equal	Equilibrium	Equals expected inflation: stable
Above	Excess supply of labour	Lower than expected, so inflation decelerates

Shifts of the natural rate:

• Down (LRPC moves left): better training, mobility, job information, less generous or shorter benefits, more flexible hiring.
• Up (LRPC moves right): hysteresis after long slumps, mismatch of skills and vacancies, rigid pay.

Evaluating the Phillips Curve

Explains well when: demand shocks dominate; expectations are stable; the period is short.

Explains poorly when:

• supply shocks push up costs while unemployment is also high
• expectations change, shifting the SRPC
• globalisation, weak bargaining power or flexible contracts flatten the curve
• unemployment is mismeasured (hidden unemployment, underemployment)
• wage growth and price inflation diverge because of productivity

Usefulness to policymakers.

• For: shows the short-run cost of disinflation; warns against pushing unemployment below NAIRU; supports credible inflation targets; points to supply-side reform.
• Against: NAIRU cannot be observed and changes; the SRPC shifts; policy lags; fine-tuning risks error.

Worked reminder: Country B, expected inflation 3%, slope 0.6, U* = 5%. For wage growth of 4.2%: U = 5 − (4.2 − 3) ÷ 0.6 = 3.0%. If U* is really 6%, the same U gives 3 + 0.6 × 3 = 4.8%, an overshoot. A small error in U* gives a large policy error.

Diagram checklist

Label the axes (unemployment % across, inflation % up) and name each curve:

Curve	Shape and position
LRPC	Vertical line at U* on the unemployment axis
SRPC, lower expected inflation	Downward-sloping, convex, crossing the LRPC at a low inflation rate
SRPC, higher expected inflation	Same shape, shifted up, crossing the LRPC at a higher inflation rate

• Two SRPCs: the higher one has higher expected inflation. Both cross the LRPC at U*.
• Government pushes unemployment left of U*: a move up the first SRPC, then a shift up to the second as expectations rise.
• Supply-side reform: LRPC shifts left to a lower U*.

A plan for an evaluation answer

1. Define the term and give the mechanism in two or three linked steps.
2. Give one or two points for and against, each with a reason.
3. Say what the answer depends on: time period, source of shock, size of expectations effect, or quality of data.
4. Reach a judgement that follows from your points and applies to the context given.

The three schools

	Keynesian	Neo-classical	Austrian
Core claim	AD drives output; slumps can persist	Markets clear; economy self-corrects	Credit expansion causes boom and bust
Wages	Sticky	Flexible	Flexible and informative
Long-run AS	Not necessarily vertical	Vertical	Set by real saving and capital
Unemployment	Can be well above natural	Mostly natural	Adjusts as malinvestment is cleared
Policy	Fiscal and monetary stimulus	Supply-side policy; stable money	Sound money; do not bail out or stimulate
Strength	Explains long slumps	Explains long-run limits of stimulus	Explains credit cycles
Weakness	Inflation, debt, lags, stagflation	Slow adjustment is costly	Remedy of letting failures run is costly

Chain of reasoning for a fall in spending

• Keynesian: spending falls, firms cut output, wages do not fall, unemployment stays high, so government raises AD.
• Neo-classical: wages and prices fall, output returns to potential, so intervention is unnecessary and may harm.
• Austrian: the fall follows an earlier credit-fuelled boom, so the bust corrects past errors, and stimulus would repeat them.

Austrian arithmetic reminder. Credit grows 8% a year for 4 years: 1.08⁴ − 1 = 36.0%. Real income grows 2%: 1.02⁴ − 1 = 8.2%. Credit has grown more than four times as fast as income.

Evaluating a school. Check the time period, the cause of the problem (demand, supply or credit) and the costs of acting or waiting. Do not declare one school simply correct.

Quick self-test

1. A country has 50 million in the labour force and 2.5 million unemployed. Calculate the unemployment rate.
2. In Country B, wage growth = 3 + 0.6 × (5 − U). Find wage growth when U = 4%.
3. State why the natural rate is called NAIRU.
4. Wage growth is 6% and productivity growth is 3%. Calculate unit labour cost growth to one decimal place.
5. Under adaptive expectations, last year’s inflation was 4% and U is 1 point below U* with slope 0.6. State this year’s inflation.
6. Why is the LRPC vertical?
7. Name two factors that would shift the LRPC left.
8. State one reason the Phillips Curve may fail to predict inflation.
9. State the Austrian explanation for a recession in one sentence.
10. State one reason Keynesians favour demand management.
11. Credit grows 8% and income 2% over four years. Calculate the cumulative growth of credit.

Answers

1. 2.5 ÷ 50 × 100 = 5.0%.
2. 3 + 0.6 × (5 − 4) = 3.6%.
3. Inflation is stable (not accelerating) at that rate because actual equals expected inflation.
4. 1.06 ÷ 1.03 − 1 = 2.9%.
5. 4 + 0.6 × 1 = 4.6%.
6. Expectations adjust until actual equals expected inflation, which holds only at the natural rate, whatever the inflation level.
7. Better training and greater labour mobility (also better job-matching or more flexible hiring).
8. Supply shocks or changed expectations shift the curve (also globalisation or mismeasured unemployment).
9. Artificially cheap credit causes malinvestment in a boom, and the recession liquidates it.
10. Wages and prices are sticky, so the economy can stay below full employment without help.
11. 1.08⁴ − 1 = 36.0%.

Where marks are usually lost

• Drawing a Phillips Curve with unemployment on the wrong axis or with no labelled axes.
• Describing the long-run curve as vertical without explaining expectations catching up.
• Saying NAIRU is the rate at which inflation is zero. It is the rate at which inflation does not accelerate.
• Treating the natural rate as zero unemployment or as including cyclical unemployment.
• Confusing wage growth with price inflation, and ignoring productivity.
• Listing weaknesses of the curve without judging how far they matter and over what period.
• Describing Keynesian, neo-classical and Austrian views in separate paragraphs and never comparing them.
• Calling a school “wrong” with no evidence or context from the question.

Official syllabus

OCR, A Level in Economics (H460) specification, Version 3.0 (June 2026), for first assessment in 2021. Topics: The Phillips Curve; Macroeconomic equilibrium (final bullet).