1. Aggregate demand, aggregate supply, and the Phillips curve In the year 2027, aggregate demand and aggregate supply in the imaginary country of Daisen-Oki are represented by the curves AD2027 and AS on the following graph. The price level is currently 102. The graph also shows two potential outcomes for 2028. The first possible aggregate demand curve is given by the curve labeled ADA curve, resulting in the outcome given by point A. The second possible aggregate demand curve is given by the curve labeled ADE, resulting in the outcome given by point B. \fSuppose the unemployment rate is 7% under one of these two outcomes and 5% under the other. Based on the previous graph, you would expect 7 to be associated with the lower unemployment rate (5%). If aggregate demand is low in 2028, and the economy is at outcome A, the inflation rate between 2027 and 2028 is V . Based on your answers to the previous questions, on the following graph use the purple point (diamond symbol) to plot the unemployment rate and inflation rate if the economy is atpoint A. Next, use the green point (triangle symbol) to plot the unemployment rate and inflation rate if the economy is at point 5. (As you place these points, dashed drop lines will automatically extend to both axes.) Finally, use the black line (cross symbol) to draw the short-run Phillips curve for this economy in 2028. Note: For graphing pruposes, round the ination rate under each outcome to the nearest whole percent. For example, round 1.9% to 2.0%. Hint: Hover your cursor over each point after you plot it to make sure you have placed it on the exact coordinate you intended. \fSuppose that the government is considering enacting an expansionary policy in 2027 that would shift aggregate demand in 2028 from ADA to ADE. This would cause a V the short-run Phillips curve, resulting in V in the inflation rate and V in the unemployment rate. 2. The Phillips curve in the short run and long run The following graph plots aggregate demand (44193027) and aggregate supply (AS) For the imaginary country of Iguazu in the year 2027. Suppose the natural level of output in this economy is $6 trillion. On the following graph, use the green line (triangle symbol) to plot the long-run aggregate supply (LRAS) curve for this economy. \fEconomists forecast that if the government takes no action and the economy continues to grow at the current rate, aggregate demand in 2028 will be given by the curve labeled ADA, resulting in the outcome given by point A. If, however, the government pursues an expansionary policy, aggregate demand in 2028 will be given by the curve labeled ADE, resulting in the outcome given by point B. The following table presents projections for the unemployment rates that would occur at point A and point B. Consider the potential rate of inflation between 2027 and 2028, depending on whether the economy moves from the initial price level of 102 to the price level at outcome A or the price level at outcome B. Complete the table by entering the inflation rate at each potential outcome point. Note: Calculate the inflation rate to two decimal points of precision. Unemployment Rate Inflation Rate A 7% % B 5% % Based on your answers to the preceding parts, use the black line (plus symbol) to draw the short-run Phillips curve (SRPC) for this economy in 2028. (Note: You will not be graded on any changes you make to this graph. )\fThe short-run Phillips curve is '7 line: 0 Representing the tradeoff between unemployment and ination 0 At the natural level of output 0 At the natural rate of unemployment Now consider the long-run effects of this policy. Suppose, in particular, that following implementation of the policy, the aggregate demand curve remains at ADE. The long-run equilibrium that would follow such a policy is designated outcome C. Going back to the first graph, place the grey point (star symbol) at outcome C. Because output at point C is the natural level of output, the unemployment rate associated with outcome C is the natural rate of unemployment. Finally, use the green line (triangle symbol) to draw the long-run Phillips curve (LRPC) on the second graph. This line is line: O At the natural level of output O Representing the tradeoff between unemployment and inflation O At the natural rate of unemployment3. The long-run effects of monetary policy The following graphs plot the long-run equilibrium situation for an economy. The first graph plots the aggregate demand (AD) and long-run aggregate supply (LRAS) curves. The second graph plots the long-run and short-run Phillips curves (LRPC and SRPC, respectively).LRAS O AD O LRAS PRICE LEVEL AD 0 2 4 6 8 10 12 OUTPUT (Trillions of dollars)LRPC O SRPC LRPC INFLATION RATE SRPC 0 3 6 9 12 15 18 UNEMPLOYMENT RATE (Percent)Which of the following statements are true based on these graphs? Check ah' that apply. C] It is impossible to determine the natural rate of unemployment from these graphs alone. C] The natural rate of unemployment is 9%. C] The natural level of output is 9%. Suppose the central bank of the economy pursues a policy that increases the money supply. Show the fang-run effects of this policy on both of the graphs by shifting the appropriate curves. The long-run effect of the central bank's policy is V in the inflation rate, V in real GDP. V in the unemployment rate, and 4. Monetary policy and the Phillips curve The following graph plots the short-run Phillips curve for a hypothetical economy. The given point on the graph indicates the initial rates of unemployment and inflation. Assume that the economy is currently in long-run equilibrium. Suppose the central bank of the hypothetical economy decides to decrease the money supply. On the followlng graph, shift the curve or drag the blue point along the curve, or do both, to show the short-run e'ects of this policy. Hint: You may assume that the central bank's move was unanticipated. \fIn the short run, an unexpected decrease in the money supply results in V in the inflation rate and V in the unemployment rate. On the following graph, shlft the curve or drag the blue point along the curve, or do both, to show the long-run effects of the decrease in the money supply. \fIn the long run, the decrease in the money supply results in V in the inflation rate and Y in the unemployment rate (relative to the economy's initial equilibrium). 5. Expectations and the Phillips curve The following graph plots the long-run Phillips curve (LRPC) and short-run Phillips curve (SRPC1 ) for an economy currently experiencing long-run equilibrium at point A (grey star symbol).\fWhich of the following is true along SRPCl ? O The expected inflation rate is 5%. O The actual unemployment rate is 6%. O The natural rate of unemployment is 3%. O The actual inflation rate is 5%. Suppose that the central bank for this economy suddenly and unexpectedly decreases the money supply in an effort to reduce inflation. As a result of this unanticipated policy action, actual inflation falls to 3%. 0n the previous graph, use the black point (plus symbol labeled \"5") to illustrate the short-run effects of this policy. Suppose that now, after a period of 3% inflation, households and firms begin to expect that the inflation rate will persist at the level of 3%. On the previous graph, use the purple iine (diamond symbol) to draw SRPCQ, the short-run Phillips curve that is consistent with these expectations, assuming that it is parallel to SRPG]. Finally, using the orange point (square symbol labeled "C" , indicate on the previous graph the new, long-run equilibrium for this economy. The inflation rate at point C is V the inflation rate at point A, and the unemployment rate at point C is V the unemployment rate at point A. Was the central bank able to achieve its goal of lowering inflation? O No, because the central bank cannot affect the inflation rate through monetary policy. 0 Yes, the central bank's policy successfully reduced inflation in both the short run and the long run. 0 Yes, but only in the short run; in the long run, inflation returned to its natural rate. Now, suppose that the public fully anticipates the central bank's decision to decrease the money supply. Assume the public also believes that the monetary authority is firmly committed to carrying out this policy. According to rational expectations theory, when the economy is in long-run equilibrium, a fully anticipated decrease in the money supply will cause the economy to move V on the previous Phillips curve graph. In this case, rational expectations theory predicts that the fully anticipated decrease in the money supply will have the immediate effect of V in the inflation rate and V in the unemployment rate. from A to B and then to C directly from A to C from A to B to C and then back to B from A to B permanently from A to B and then back to A 6. The costs of disinflation The following graph plots the short-run and long-run Phillips curves (SRPC and LRPC, respectively) for an economy currently experiencing long-run macroeconomic equilibrium at point A, where the natural unemployment rate is 6% and the inflation rate is 8% per year.\fSuppose that the central bank for this economy has decided that inflation is too high and thus wants to decrease the inflation rate by 6 percentage points per year. A reduction in the rate of inflation is known as V . To reduce inflation from 8% to 2% in the short run, the central bank would have to accept an unemployment rate MC]. True or False: If people have rational expectations, the sacrifice ratio could be much higher than suggested by the short-run Phillips curve. 0 True 0 False