Ch19: Short-run trade-off between inflation and employment

Question 1

Cost of lowering unemployment by increasing AD?

Answer 1

Increasing inflation, vice versa.

Question 2

What does Phillips Curve illustrate?

Answer 2

Short run relationship between unemployment and inflation.

Question 3

What is the Long Run Phillips Curve?

Answer 3

Phillips curve is vertical. Unemployment doesn’t depend on Money Supply nor inflation in the long run.

Question 4

Effect of shift in LRPC?

Answer 4

LRAS will shift also.

Question 5

Formula for Unemployment Rate?

Answer 5

Unemployment Rate = NRU -a ( Actual - excepted inflation).

Question 6

Central bank’s ability to create unexpected inflation in the SR and LR?

Answer 6

Only in the SR. People will expect inflation in the LR, so will be at NRU in LR.

Question 7

Phillips Curve and AD/AS Relationship

Answer 7

A -> B: Y increases, unemployment falls. Inflation increases.
B -> C: Wages increase, so costs increase. This causes SRAS to shift left. Y falls, unemployment rises, inflation rises.

Question 8

What is natural-rate hypothesis theory?

Answer 8

Policymakers increasing employment by also inducing higher inflation. Only works temporarily. Over time, wages will rise and AS will shift left.

Question 9

Combating adverse supply shocks?

Answer 9

Increasing/decreasing AD will normalise in the long run.

Leaving economy alone may by the way, as AS will eventually shift back.

Question 10

What is the sacrifice ratio?

Answer 10

Number of percentage points of annual output lost in the process of reducing inflation by one percentage point.

Estimate of around five. e.g. to reduce inflation from 20% to 4%, a sacrifice of 80% output required.