6. 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 AD2027AD2027and 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 ADAADAcurve, resulting in the outcome given by point A. The second possible aggregate demand curve is given by the curve labeled ADBADB, resulting in the outcome given by point B.

0246810121416108107106105104103102101100PRICE LEVELOUTPUT (Trillions of dollars)ADAADBAD2027ABAS

Suppose the unemployment rate is 5% under one of these two outcomes and 3% under the other. Based on the previous graph, you would expectoutcome A to be associated with the lower unemployment rate (3%).

If aggregate demand is high in 2028, and the economy is at outcome B, the inflation rate between 2027 and 2028 is3.00% .

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 at point A. Next, use the green point (triangle symbol) to plot the unemployment rate and inflation rate if the economy is at point B. (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 inflation 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.

Outcome AOutcome BPhillips Curve012345678876543210INFLATION RATE (Percent)UNEMPLOYMENT RATE (Percent)6, 1

Suppose that the government is considering enacting an expansionary policy in 2027 that would shift aggregate demand in 2028 from ADAADAto ADBADB. This would cause amovement along the short-run Phillips curve, resulting inan increase in the inflation rate anda decrease in the unemployment rate.