Chapter 6

Question 1

Difference between the Philips curve and AS?

Answer 1

The Philips curve links inflation and unemployment, while AS links price and inputs

Question 2

What type of relationship do unemployment and money wages have?

Answer 2

inverse

Question 3

Are wages rising/falling if unemployment is above the natural rate?

Answer 3

falling

Question 4

Two key properties of the expectations-augmented Philips curve:

Answer 4

1. Expected inflation maps one-to-one into actual inflation
2. Unemployment is at the natural rate when actual inflation equals expected inflation

Question 5

Where does the expectations augmented Philips curve interest the natural unemployment rate?

Answer 5

At the level of expected inflation

Question 6

What is stagflation?

Answer 6

high unemployment at the same time as high inflation

Question 7

What did Robert Lucas argue?

Answer 7

A good economic model should not rely on the public making easily avoidable mistakes

Question 8

What is the rational expectations model?

Answer 8

Predicts inflation based on information available to the public

Question 9

If there is over-employment, what does it do to the wage-employment relation?

Answer 9

it shifts it upwards

Question 10

Three reasons for wage and price stickiness?

Answer 10

1. Imperfect information
2. Coordination Problems
3. Efficiency wages and costs of price changes

Question 11

What is the insider outsider model?

Answer 11

A prediction that wages will not respond substantially to unemployment and is another explanation as to why we do not quickly return to full employment after a recession

Question 12

What is a supply shock?

Answer 12

A disturbance to the economy that shifts the aggregate supply curve

Question 13

What is an adverse supply shock?

Answer 13

A shock that shifts AS to the left, causes prices to increase and output to fall

Question 14

What are the two types of supply shock?

Answer 14

transitory and not transitory

Question 15

What happens if a supply shock is transitory?

Answer 15

the cost of production returns to its initial level, AS shifts back

Question 16

What happens if a supply shock is not transitory?

Answer 16

If the government does not intervene, the higher unemployment forces wages and, thus, the price level down

Question 17

What are accommodation policies?

Answer 17

Monetary and fiscal policies that increase AD and offset supply shock

Question 18

What policy can be used in the case of a permanent supply shock?

Answer 18

None, use of policy will only higher prices

Question 19

What is a favourable supply shock?

Answer 19

Moves the SR AS downwards

Question 20

What policy can be used on a favourable supply shock?

Answer 20

Contractionary policy measures are appropriate to shift AD to the left

Question 21

What is the political business cycle theory?

Answer 21

Studies interactions between economic policy decisions and political considerations

Question 22

What may politicians do to put the business cycle in their favour? (2 things)

Answer 22

• Use restrictive policies early to raise unemployment and lower inflation
• as the election approaches, use expansionary policy to lower unemployment

Question 23

By how much does one point of extra unemployment reduce inflation in the short run Philips curve?

Answer 23

0.3 points

Question 24

What is the main argument of rational expectations theory?

Answer 24

Aggregate supply should shift very quickly in response to anticipated changes in AD

Question 25

Does Canadian evidence support a political business cycle?

Answer 25

no