2. The Phillips curve in the short run and long run

In the year 2023, aggregate demand and aggregate supply in the fictional country of Marjan are represented by the curvesAD2023AD2023and AS on the following graph.

Suppose the natural level of output in this economy is $7 trillion.

On the following graph, use the green line (triangle symbol) to plot the long-run aggregate supply (LRAS) curve for this economy.

Economists have forecast that if the government does nothing and the economy continues to grow at the current rate, aggregate demand in 2024 will be given by theADAADAcurve, resulting in the outcome illustrated by point A. If the government pursues a contractionary policy, aggregate demand in 2024 will be given by theADBADBcurve, resulting in the outcome illustrated by point B.

The following table gives projections for the unemployment rates that would occur at point A and point B. Consider what the rate of inflation would be between 2023 and 2024, 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 3%

B 6%

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 2024. (Note: You will not be graded on any changes you make to this graph.)

The short-run Phillips curve is a vertical/ an upward-sloping/ a downwardline:

Representing the tradeoff between unemployment and inflation

At the natural level of output

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 atADBADB. Designate the long-run equilibrium that would follow such a policy as outcome C.

Going back to thefirstgraph, place the grey point (star symbol) at outcome C.

Because output at point C is greater than/ equal to/ less thanthe natural level of output, the unemployment rate associated with outcome C is greater than/equal to/less thanthe natural rate of unemployment.

Finally, use the green line (triangle symbol) to dra

On the following graph, use the green line (triangle symbol) to plot the long-run aggregate supply (LRAS) curve for this economy. 108 A 107 LRAS AS 106 A 105 Outcome C 104 PRICE LEVEL AD 2023 103 ADA 102 ADB 101 100 0 2 4 6 8 10 12 14 16 OUTPUT (Trillions of dollars)