We return to Isolanda in 2025, and they are having difficulties with high levels of inflation. In 2025 they are in long-run equilibrium, with real GDP of $100 billion, unemployment of 5% and inflation of 10%. Figure 2 depicts several short run Phillips curves (SRPC) and the long run Phillips curve (LRPC) for Isolanda's economy. Each SRPC is labeled with a number, which represents the expected inflation rate associated with that particular curve. Point B on the graph idicates Isolanda's unemployment and inflation rates in 2025. The president tells you that she would like to get expected inflation down to 8% by 2027 by using monetary policy. What would you advise her to do in 2026 to achieve this goal? Explain how your proposal will achieve the president's goal (and be sure to include in your explanation how the unemployment rate will be affected by your proposal). The labor force in Isolanda in 2025 consists of 1 million people. Assume that no one will enter or leave the labor force in 2026 or 2027 (i.e. the labor force in 2026 and 2027 will also consist of 1 million people). b. How many people were unemployed in Isolanda in 2025? c. If the president adopts your proposal, how many people will be unemployed in 2026? d. Using Okun's Law, calculate how much of an output gap will result in the short-run from the policy you proposed (and be sure to indicate whether the amount of the gap is positive or negative). (Note: your answer should be expressed as a percentage of potential output.) e. By how much (in dollars) will real GDP increase or decrease in the short run as a result of your proposed policy? (Assume that potential output remains constant from 2025 to 2027). Figure 2 16.0% LPPC 14.0% 12.0% 10.0% 00 8.0% SRPC10 INFLATION RATE 6.0% SPPC8 4.0% SRPC6 2.0% SAPC4 0.0% 0.0% -2.0% 1.0% 2.0% 3.0% 4.0% 5.0% 7.0% SPC2.0% SHRC0 -4.0% UNEMPLOYMENT RATE We return to Isolanda in 2025, and they are having difficulties with high levels of inflation. In 2025 they are in long-run equilibrium, with real GDP of $100 billion, unemployment of 5% and inflation of 10%. Figure 2 depicts several short run Phillips curves (SRPC) and the long run Phillips curve (LRPC) for Isolanda's economy. Each SRPC is labeled with a number, which represents the expected inflation rate associated with that particular curve. Point B on the graph idicates Isolanda's unemployment and inflation rates in 2025. The president tells you that she would like to get expected inflation down to 8% by 2027 by using monetary policy. What would you advise her to do in 2026 to achieve this goal? Explain how your proposal will achieve the president's goal (and be sure to include in your explanation how the unemployment rate will be affected by your proposal). The labor force in Isolanda in 2025 consists of 1 million people. Assume that no one will enter or leave the labor force in 2026 or 2027 (i.e. the labor force in 2026 and 2027 will also consist of 1 million people). b. How many people were unemployed in Isolanda in 2025? c. If the president adopts your proposal, how many people will be unemployed in 2026? d. Using Okun's Law, calculate how much of an output gap will result in the short-run from the policy you proposed (and be sure to indicate whether the amount of the gap is positive or negative). (Note: your answer should be expressed as a percentage of potential output.) e. By how much (in dollars) will real GDP increase or decrease in the short run as a result of your proposed policy? (Assume that potential output remains constant from 2025 to 2027). Figure 2 16.0% LPPC 14.0% 12.0% 10.0% 00 8.0% SRPC10 INFLATION RATE 6.0% SPPC8 4.0% SRPC6 2.0% SAPC4 0.0% 0.0% -2.0% 1.0% 2.0% 3.0% 4.0% 5.0% 7.0% SPC2.0% SHRC0 -4.0% UNEMPLOYMENT RATE
