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Finance & Investing

Phillips Curve

Model #0718Category: Finance & InvestingSource: A.W. Phillips / Milton Friedman / Edmund PhelpsDepth to apply:

By Updated 3 sources

4 min read

Contents

  1. 1. Core Idea
  2. 2. How to See It
  3. 3. How to Use It
  4. 4. Founders & Leaders
  5. 5. Connected Models
  6. 6. One Key Quote
  7. 7. Summary & Further Reading
Finance & Investing
Section 1

Core Idea

The Phillips Curve describes the observed inverse relationship between unemployment and inflation: when unemployment falls, wages and prices tend to rise, and vice versa. Originally an empirical finding (A.W. Phillips, 1958), it became central to macroeconomic policy — the idea that policymakers face a trade-off between the two. Later work (Friedman, Phelps) showed the trade-off is short-run only; in the long run, expectations adjust and the curve shifts. For founders, the mental model is broader: many systems present apparent trade-offs that hold in the short term but break down as participants adapt. Beware optimising one variable and assuming the other stays fixed.

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Section 2

How to See It

Macro & Markets
You're seeing it when a hot labour market drives wage inflation and compresses margins. Hiring costs rise fastest when talent is scarce — the Phillips trade-off playing out in your P&L.
Company Growth
You're seeing it when rapid scaling (low "unemployment" of resources) creates quality or cost inflation — more hires, more overhead, more coordination cost. Growth has an inflation equivalent.
Section 3

How to Use It

Recognise the short-run trade-off: pushing hard on one variable (growth, hiring, spend) often inflates another (cost, complexity, dilution). Plan for the second-order effect, not just the first. And remember the long-run lesson — participants adapt. A wage hike today becomes the new baseline tomorrow; expectations reset. Build strategy for the world after the adjustment, not just the current curve.
Decision filter
"Are we treating a short-run trade-off as permanent? What happens when expectations adjust — does our advantage hold?"
As a founder
Use the Phillips Curve lens when planning aggressive hiring or spending cycles. The short-run gain (more output) comes with an inflation cost (higher burn, compressed margins). Model both sides and plan for the adjustment period when the trade-off shifts.
Section 5

Founders & Leaders

George SorosFounder, Soros Fund Management; macro investor
Soros built his career reading macro trade-offs that others treated as stable. His theory of reflexivity — that market participants' beliefs change the fundamentals — parallels the Phillips Curve's long-run breakdown: the trade-off shifts as expectations adapt. Founders can apply this lens by questioning any "stable trade-off" in their business. If you're exploiting a pricing gap, a talent arbitrage, or a cost advantage, ask how long before the other side of the curve adjusts. The edge isn't in finding the trade-off — it's in anticipating when it moves.
Section 7

Connected Models

Reinforces
Supply and Demand
The Phillips Curve is a specific application of supply-demand dynamics in labour markets. When labour supply tightens, price (wages) rises. The general model applies everywhere you see the trade-off.
Tension
Goodhart's Law
When policymakers target the Phillips trade-off directly (e.g. targeting a specific unemployment rate), the relationship breaks — expectations adjust and the curve shifts. Goodhart's Law explains why the trade-off is unstable when used as a policy lever.
Leads-to
[AD-AS Model](/mental-models/ad-as-model)
The Phillips Curve feeds into aggregate demand–aggregate supply analysis. Understanding the unemployment-inflation trade-off is one input to the broader macro picture of output, price levels, and policy.
Section 8

One Key Quote

"There is always a temporary trade-off between inflation and unemployment; there is no permanent trade-off."
— Milton Friedman, 1968 AEA Presidential Address
Section 11

Summary & Further Reading

The Phillips Curve describes a short-run trade-off between unemployment and inflation that breaks down as expectations adjust. Use it to recognise that apparent trade-offs in your business may shift when participants adapt — plan for the world after the adjustment.
01
02
The Role of Monetary Policy — Milton Friedman (1968)
Paper
The expectations-augmented critique that reshaped macro policy thinking.
03
The Alchemy of Finance — George Soros (1987)
Book
Reflexivity and why macro trade-offs shift when participants act on them.

Why this matters next

mental modelsSupply and Demand

Phillips Curve applied the Supply and Demand mental model

mental modelsTrade-offs

Phillips Curve applied the Trade-offs mental model

mental modelsQuality

Phillips Curve applied the Quality mental model

mental modelsInflation

Phillips Curve applied the Inflation mental model

mental modelsOne Variable

Phillips Curve applied the One Variable mental model

mental modelsCost

Phillips Curve applied the Cost mental model

Frequently asked questions

What is Phillips Curve?

Phillips Curve is a mental model used for better thinking and decision-making.

How do you apply Phillips Curve?

To apply Phillips Curve, identify situations where this framework is relevant, then use it as a lens to evaluate your options and decisions. The model is most useful when combined with other complementary mental models.

What category does Phillips Curve fall under?

Phillips Curve falls under the Finance & Investing category of mental models. Other models in this category can be found on the Finance & Investing hub page.

Why is Phillips Curve important?

Phillips Curve is important because it provides a structured way to think about problems that would otherwise be approached with intuition alone. Understanding this model helps you avoid common reasoning errors and make better decisions.

Where does Phillips Curve come from?

Phillips Curve is discussed in the tradition of A.W. Phillips / Milton Friedman / Edmund Phelps.

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