Section 16

After the War of the Rings, Legolas returns to Mirkwood, where his father rules the Woodland Elves. Due to new ideas gained in his wide travels, Legolas convinces King Thranduil to implement continuing expansionary monetary and fiscal policy to reduce unemployment in Mirkwood. (Actually, a reduction in the consumption of barrels of wine would work better.)

a) Draw and explain the short-run Phillips curve for the economy of Mirkwood on which Legolas is basing his ideas. What is held constant along the short-run Phillips curve? What is the tradeoff in the short-run?

b) Draw the combined short-run and long-run Phillips curves for the Mirkwood economy. Explain what happens to the price level and unemployment in the long run? Is there any tradeoff in the long-run?

c) Explain and show by graph the connection through unemployment and changes in the price level between the business cycle as shown by the AD/AS model and the long run Phillips curve (show 3 points on the graph).

d) Suppose job search time in Mirkwood suddenly becomes easier. Draw and explain what happens to the Phillips curve in Mirkwood.