2. The Phillips curve in the short run and long run The following graph plots aggregate demand (AD2027) and aggregate supply (AS) For the imaginary country of Patagonia in the year 2027. Suppose the natural level of output in this economy is $10 trillion. On the following graph, use the green line (triangle symbol) to plot the long-run aggregate supply (LRAS) curve for this economy. Which of the following statements are true based on these graphs? Check all that apply. C] The natural level of output is $3 trillion. C] The unemployment rate is currently 6% higher than the natural rate of unemployment. C] The current quantity of output is greater than potential output. Suppose the central bank of the economy pursues a policy that decreases the money supply. Show the long-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 ination 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 equilibrlum. Suppose the central bank of the hypothetical economy decides to decrease the money supply. On the following graph, shift the curve or drag the blue point along the curve, or do both, to show the short-run eh'ects of this policy. Hint: You may assume that the central bank's move was unanticipated. \f1n the short run, an unexpected decrease in the money.r supply results in V in the inflation rate and V in the unemployment rate. On the following graph, shift 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 in the inflation rate and 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 SRPC1 ? 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%. On the previous graph, use the black paint (plus symbol labeled "5") to illustrate the short-run eh'ects 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 line (diamond symbol) to draw SRPCg, the short-run Phillips curve that is consistent with these expectations, assuming that it is parallel to SRPC]. 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 NoI 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 '7 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. \ffrom 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 Economists 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 a contractionary 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 B or the price level at outcome A. 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 E 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 line: O Representing the tradeoff between unemployment and inflation O At the natural level of output O 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 ADB. 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 7 line: 0 At the natural rate of unemployment 0 At the natural level of output 0 Representing the tradeoff between unemployment and inflation 3. 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).