5. The derivation of the short-run and long-run Phillips curve Suppose the price level in a hypothetical economy is currently 100, but people expect prices to be 10% higher next year. Therefore, wage contracts negotiated by workers and firms reflect the expectation that the price level will be 110 next year. The following graph shows the aggregate demand curve (AD110), the short-run aggregate supply curve (AS110) for this economy. Use the following graph to answer the questions that follow. (Note: You will not be graded for any adjustments made to this graph.) 120 O 118 AS 110 116 AD 110 114 112 AS 1 10 PRICE LEVEL 110 A 108 Potential GDP 106 AD 110 104 102 100 2 10 12 14 16 18 20On the previous graph, shift the AD curve to illustrate the position of aggregate demand if actual inflation is higher than expected. Read the resulting price level and enter the inflation rate into a corresponding cell in the "Inflation Rate" column in the following table. On the previous graph, shift the AD curve to illustrate the position of aggregate demand if actual inflation is lower than expected. Read the resulting value price level and enter the inflation rate into a corresponding cell the "Inflation Rate" column in the following table. Unemployment Rate Inflation Rate (Percent) (Percent) 6 10 10 16 On the following graph, use the purple curve (diamond symbols) to plot the short-run Phillips curve using exactly three points. Then use the green line (triangle symbols) to draw the long-run Phillips curve for this economy.On the following graph, use the purple curve (diamond symbols) to plot the short-run Phillips curve using exactly three points. Then use the green line (triangle symbols) to draw the long-run Phillips curve for this economy. 20 18 Short-run Phillips curve A 14 12 Long-run Phillips curve 10 INFLATION RATE (Percent) CO 0 2 4 8 10 12 14 16 18 20 UNEMPLOYMENT RATE (Percent) The natural rate of unemployment for this economy is percent