The Phillips curve is a graph showing the relationship between the inflation rate and the rate of unemployment. In the short run, the Phillips curve has a downward slope, indicating a possible tradeoff between inflation and unemployment. In the long run, the Phillips curve is vertical, indicating that no such tradeoff is possible. The short-run downward slope of the Phillips curve is caused by shifts in aggregate demand while aggregate supply stays constant. In the long run no tradeoffs are possible because adaptations are made and the aggregate supply curve shifts.
Unexpected inflation can decrease unemployment in three ways.
If workers have constant reservation wages and constant expectations about inflation, an unexpected increase in inflation raises nominal wages without raising real wages. Workers do not realize that inflation has increased, so they accept smaller real wages and unemployment decreases. When aggregate demand is greater than expected, inventories fall and prices on remaining goods in stock are higher. Businesses hire new workers to increase production to offset the falling inventories. If wage contracts exist, employers must adjust employment to changing conditions.