Phillips Curve

The Phillips curve shows the relationship between unemployment and inflation. Unemployment is on the x-axis and inflation is on the y-axis. When deflation occurs, the curve will cross the y-axis. In the short run, this curve is downward sloping. When unemployment is low, inflation is high and vice versa. In the long run, the curve is vertical because the economy is expected to reach full employment.
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The Phillips Curve - 60 Second Adventures in Economics (3/6)

Rational Expectations Theory

The rational expectations theory affects the Phillips curve. Because people anticipate and act upon what they expect to happen, their actions cause the intended outcome of the Phillips curve to change. If people expect inflation, then they demand higher wages. This causes AS to decrease, which causes more inflation. The intended outcome is for the economy to move along the short run curve, but this theory can cause the economy to move along the long run curve.