Suppose the economy is operating below potential output. Inflation is 2% and expected inflation is 3%. The unemployment rate is 8% and the natural unemployment rate is 4%.

a.Draw a long-run Phillips curve and a short-run Phillips curve consistent with these conditions.

b.The government implements expansionary monetary policy. As a result, unemployment decreases to 6% and inflation increases to 2.5%. Expectations however, do not change. Show where the economy is on the graph you drew for (a) above. What happens to the long-run Phillips curve?

c.Expectations now fully adjust. Show this on the graph in (a) above. What happens to the short-run Phillips curve?