ECO 2020

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5. The Phillips curve in the late 20th century The following table presents historical unemployment and inflation data in the United States for the years 1977 through 1981. Unemployment Rate Inflation Rate Year Percent (Percent) 1977 7.1 6.5 1978 6.1 7.6 1979 5.8 11.3 1980 7.1 13.5 1981 7.6 10.3 Plot the data for these five years on the following graph. Note: You will not be graded on how you plot the points, but plotting the points accurately on the graph will help you examine the relationship between unemployment and inflation during this period and solve the problems that follow. (? ) 15 14 Data Points INFLATION RATE (Percent 4 5 6 7 9 10 11 UNEMPLOYMENT RATE (Percent)Which of the following statements most accurately describes the relationship between inflation and unemployment in the United States during this time period? O The short-run Phillips curve remained stable. The short-run Phillips curve shifted to the right after actual inflation was higher than expected. The short-run Phillips curve shifted to the left after actual inflation was lower than expected. The following graph shows the short-run Phillips curve (SRPC) for the United States in 1977. Shift the curve to illustrate what happened between 1977 and 1981. (? ) O SRPC INFLATION RATE SRPC. SRPC, UNEMPLOYMENT RATE The following graph shows the aggregate demand (AD) and short-run aggregate supply (AS) curves for the United States in 1977.Shift the aggregate supply curve to approximate what happened between 1977 and 1981. O AD AS AS PRICE LEVEL AD OUTPUT Grade It Now Save & Continue2. The Phillips curve in the short run and long run The following graph plots aggregate demand (A Dagey) and aggregate supply (AS) for the imaginary country of Cotopaxi 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. @ 107 Outcome C PRICE LEVEL g AD ---+ 101 + 0 2 4 g B 10 12 14 18 QUTPUT (Trillions of dollars) 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 AID4, 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 ADg, resulting in the outcome given by point B. The following table presents projections for the unemployment rates that would occur at point & 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 Based on your answers to the preceding parts, use the black line (plus symbol) to draw the short-run Phillips curve (SRPC) for this ecor (Note: You will not be graded on any changes you make to this graph.) ? - SRPC & it 1 LRPC IMFLATICMN RATE (Fercent) - o 1 + + + + i D 1 2 3 4 5 B 7 B UNEMPLOYMENT RATE (Percent) The short-run Phillips curve is w line: C) Representing the tradeoff between unemployment and inflation O 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 at ADg. 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 w the natural level of output, the unemployment rate associated with outcome C is w 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 w_line: ) At the natural rate of unemployment (Z) Representing the tradeoff between unemployment and inflation ) At the natural level of output 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). LRAS O AD O LRAS PRICE LEVEL AD 2 3 5 OUTPUT (Trillions of dollars)(?) LRPC SRPC LRPC INFLATION RATE SRPC 2 6 10 12 UNEMPLOYMENT RATE (Percent) Which of the following statements are true based on these graphs? Check all that apply. The natural level of output is $3 trillion. The unemployment rate is currently 6% higher than the natural rate of unemployment. O 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 in the inflation rate, in the unemployment rate, and in real GDP. Grade It Now Save & Continue7. The costs of disinflation The following graph plots the short-run and long-run Phillips curves (SRPC and LRPC, respectively) for an economy currently experiencing long-run macroeconomic equilibrium at point A, where the natural unemployment rate is 4% and the inflation rate is 10% per year. 20 LRPC A INFLATION RATE ( Percent) SRPC N 9 10 UNEMPLOYMENT RATE (Percent) Suppose that the central bank for this economy has decided that inflation is too high and thus wants to decrease the inflation rate by 4 percentage points per year. A reduction in the rate of inflation is known as _deflation . To reduce inflation from 10% to 6% in the short run, the central bank would have to accept an unemployment rate of 8% . True or False: If people have rational expectations, the sacrifice ratio could be much higher than suggested by the short-run Phillips curve. True O False Grade It Now Save & Continue