05.02THE PHILLIPS CURVE

For each prompt below, carefully and thoroughly follow the directions. For the graphs, be certain to accurately label all axes, curves, and equilibria points as appropriate. Use arrows to indicate the direction of any shifts.

An economy has a natural unemployment rate of 3%, an actual unemployment rate of 8%, and an inflation rate of 4%.

(a) Draw a fully labeled graph of the short-run and long-run Phillips curves. Label the current short-run equilibrium Z, and plot the numerical values on your graph.

(b) What is the cyclical unemployment rate in this economy?

(c) What would be the impact on the short-run Phillips curve if the government increases spending? Explain.

(d) What will happen to the long-run Phillips curve if the government pursues expansionary policy?

(e) Assume that a government policy successfully restores full employment. Illustrate the outcomes of this policy on your graph from part (a).

(f) Identify one action the government may have taken in part (e).

(g) Assume an overheating economy has high inflation. Using completely labeled side-by-side AD-AS and Phillips curve graphs, illustrate the process and outcomes of long-run self-adjustment in the economy without government intervention.