The following graph shows an economy in long-run equilibrium at point A (grey star symbol). The vertical line is the long-run Phillips curve (LRPC). The downward-sloping curve labeledSRPC1SRPC1is the short-run Phillips curve passing through point A.

Which of the following is true alongSRPC1SRPC1?

The natural rate of unemployment is 3%.

The actual inflation rate is 5%.

The expected inflation rate is 5%.

The actual unemployment rate is 6%.

Suppose that the Fed suddenly and unexpectedly decreases the money supply in an effort to reduce inflation. As a result of this unanticipated 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.

Now, suppose that?after a period of 3% inflation?households and firms begin to expect that the inflation rate will continue to be 3%.

On the previous graph, use the purple line (diamond symbol) to drawSRPC2SRPC2, the short-run Phillips curve that is consistent with these expectations, assuming that it is parallel toSRPC1SRPC1.

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 higher than/ the same as/lower thanthe inflation rate at point A, and the unemployment rate at point C is lower/ higher/ the same asthe unemployment rate at point A.

Was the Fed able to achieve its goal of lowering inflation?

Yes, but only in the short run; in the long run, inflation returned to its natural rate.

Yes, the Fed's policy successfully reduced inflation in both the short run and the long run.

No, because the Fed cannot affect the inflation rate through monetary policy.

Now, suppose that the publicfully anticipatesthe Fed's decision to decrease the money supply. Assume the public also believes that the Fed 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 directly from A to B/ from A to B and then to C/ from A to B permanently/ from A to B to C and the back to B/ from A to B and then back to A on the previous Phillips curve graph. In this case, rational expectations theory predicts that the fully anticipated decrease in the money supply will have theimmediateeffect of An increase/ a decreaseo change in the inflation rate and no change/ an increase/ a decrease in the unemployment rate.

The following graph shows an economy in long-run equilibrium at point A (grey star symbol). The vertical line is the long-run Phillips curve (LRPC). The downward-sloping curve labeled SRPC is the short-run Phillips curve passing through point A. 8 SRPC LRPC 7 B 6 A 5 SRPG2 4 INFLATION RATE (Percent) 3 C 2 1 0 1 2 3 4 5 6 7 8 UNEMPLOYMENT RATE (Percent)