1. Consider an economy in long-run equilibrium with an inflation rate, 'TT, of 12°/o (0.12) per year and a natural unemployment rate, u, of 6°/o (0.06). The expectationsaugmented Phillips curve is 'TT == 'TT e - 2( u - u). Assume that Okun's law holds so that a 1 percentage point increase in the unemployment rate maintained for one year reduces GDP by 2°/o of full-employment output.

a. Consider a two-year disinflation. In the first year 1T == 0.04 and 1T e == 0.08. In the second year 1T == 0.04 and 1T e == 0.04. In the first year, what is the unemployment rate? By what percentage does output fall short of full-employment output? In the second year, what is the unemployment rate? By what percentage does output fall short of full-employment output? What is the sacrifice ratio for this disinflation?

b. Now consider a four-year disinflation according to the following table: Year 1T 1 0.08 0.10 2 0.04 0.08 3 0.04 0.06 4 0.04 0.04 What is the unemployment rate in each of the four years? By what percentage does output fall short of full-employment output each year? What is the sacrifice ratio for this disinflation?