1. Aggregate Supply and Phillips Curve: Let's consider the equivalence between the SRAS curve and the Phillips Curve.

The SRAS curve given by the sticky price model may be written as:

P=Pe+[(1s)as](YY)+

The corresponding short run Phillips Curve may be written as:

=e(uun)+

where we have used Okun's law to obtain the Phillips curve from the SRAS curve. Try to answer the following questions.

a. On a sheet of paper, draw 2 diagrams. The first is for the SRAS curve, and the second is for the short run Phillips Curve. What do they look like in their respective spaces (i.e. in {P , Y} space for the SRAS and in {,U} space for the Phillips Curve). Take a photo of the paper and post it in with your answer here to show what it looks like. (Alternatively, draw it out in something like Powerpoint or Word and upload it here onto Canvas when you answer - which might be more work).

b. What do the long-run aggregate supply and Phillips curve look like in their corresponding spaces? Draw them in the same charts as part a above. (Hint: think about what assumptions we might make in the equations above in order to be able to draw out these curves) Where do the short and long run curves intersect (i.e. what values of prices and output - for the aggregate supply curve; what values of inflation and unemployment - for the Phillips curves)?

c. Suppose that there is a supply (price/inflation) shock, i.e. >0 . What happens to each of these curves (i.e. both short run and long run curves)?

d. Suppose that inflation expectations increase. What happens to each of these curves?

2. Phillips Curve: Suppose that an economy has the Phillips Curve:

=10.5(uun)

and the natural rate of unemployment is given by an average of the past two years' unemployment:

un=0.5(u1+u2)

a. Why might the natural rate of unemployment depend on recent unemployment (as is assumed in the preceding equation)?

b. Suppose that the Fed follows a policy to permanently reduce the inflation rate by 1 percentage point. What effect will that policy have on the unemployment rate over time?

c. What is the sacrifice ratio in this economy? Explain. (You may assume that Okun's Law holds, and that a 1% change in unemployment corresponds to a -2% change in the economic growth rate)

d. What do these equations imply about the short-run and long-run tradeoffs between inflation and unemployment?