Q1. Suppose the short run Phillips Curve is given by the following equation: _t= _t-1 + 0.2(y_t 100)

The coefficient 0.2 reflects the short run trade-off between inflation and output. It shows that if we want one extra unit of output, we shall have to accept a 2% increase in inflation, or if we cut output by one unit, inflation will fall by 2% . Conversely, if we want to cut inflation by 1%, output will fall by 5(=1/0.2) units.

The coefficient also shows the strength of the workers bargaining power at any given level of employment and output. Greater bargaining strength will lead to a higher value of the coefficient.

Illustrate this on a graph.