Question 5

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 1974 through 1978. Unemployment Rate Inflation Rate Year (Percent) (Percent) 1974 3.6 11.0 1975 8.5 9.1 1976 7.7 5.8 1977 7.1 6.3 1978 6.1 7.6 Piot 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. 7 @ Data Points INFLATION RATE (Fercent 4 t t t t t t t t 1 2 3 4 8 8 T B 9 10 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. O 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 1974. Shift the curve to illustrate what happened between 1974 and 1978. (? ) O SRPC INFLATION RATE SRPG UNEMPLOYMENT RATEThe following graph shows the aggregate demand (AD) and short-run aggregate supply (AS) curves for the United States in 1974. Shift the aggregate supply curve to approximate what happened between 1974 and 1978. O AD AS AS PRICE LEVEL AD OUTPUT Grade It Now Save & Continue6. Expectations and the Phillips curve The following graph plots the long-run Phillips curve (LRPC) and short-run Phillips curve (SRPC1) for an economy currently experiencing long-run equilibrium at point A (grey star symbol). (? GRPC. LRPC 7 B SRPG2 INFLATION RATE (Percent) C 2 5 7 UNEMPLOYMENT RATE (Percent) Which of the following is true along SRPCi? The actual unemployment rate is 6%. The actual inflation rate is 5%. The natural rate of unemployment is 3%. The expected inflation rate is 5%.Suppose that the central bank for this economy suddenly and unexpectedly decreases the money supply in an effort to reduce inflation. As a result of this unanticipated policy action, actual inflation falls to 3%. On the previous graph, use the black point (plus symbol labeled "B") to illustrate the short-run effects of this policy. Suppose that now, after a period of 3% inflation, households and firms begin to expect that the inflation rate will persist at the level of 3%. On the previous graph, use the purple line (diamond symbol) to draw SRPC2, the short-run Phillips curve that is consistent with these expectations, assuming that it is parallel to SRPCi. Finally, using the orange point (square symbol labeled "C"), indicate on the previous graph the new, long-run equilibrium for this economy. The inflation rate at point C is the inflation rate at point A, and the unemployment rate at point C is the unemployment rate at point A. Was the central bank able to achieve its goal of lowering inflation? O Yes, but only in the short run; in the long run, inflation returned to its natural rate. O Yes, the central bank's policy successfully reduced inflation in both the short run and the long run. No, because the central bank cannot affect the inflation rate through monetary policy. Now, suppose that the public fully anticipates the central bank's decision to decrease the money supply. Assume the public also believes that the monetary authority is firmly committed to carrying out this policy. According to rational expectations theory, when the economy is in long-run equilibrium, a fully anticipated decrease in the money supply will cause the economy to move on the previous Phillips curve graph. In this case, rational expectations theory predicts that the fully anticipated decrease in the money supply will have the immediate effect of in the inflation rate and in the unemployment rate. 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 6% and the inflation rate is 8% per year. LRPC INFLATION RATE (Percent) SRPC 2 6 8 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 6 percentage points per year. A reduction in the rate of inflation is known as . To reduce inflation from 8% to 2% in the short run, the central bank would have to accept an unemployment rate of True or False: If people have rational expectations, the sacrifice ratio could be much smaller than suggested by the short-run Phillips curve. True O False Grade It Now Save & Continue