Consider a hypothetical economy in which policy makers have never used inflation to try to stimulate the economy. Let's say that inflation is 0 percent and market participants expect 0 percent inflation going forward. In addition, the natural rate of unemployment is 6 percent.

a.Draw a diagram representing the short- and long-run Phillips curves with expected inflation and actual inflation on theyaxis and the unemployment rate on thexaxis.

b.Show what happens in the short run if the central bank of this economy decides to enact policy that raises the inflation rate to 3 percent.

c.Because the inflation rate is 3 percent, market participants expect a 3 percent inflation rate. Show what impact this has on the short-run Phillips curve.

d.Discuss how this demonstrates the long-run Phillips curve.