Philips Curve

Question 1

What does the Philips Curve show?

Answer 1

In SR- Inflation + Output/Unemployment are related

SR Trade off between Inflation + Unemployment

Question 2

How does Expansionary Policy affect Output + Inflation?

Answer 2

Increases Output + Inflation

Question 3

What is the Trade off in the Philips Curve?

Answer 3

Increased AD –> Increased Output + Increased PL
– Increased Inflation + Decreased Unemployment
DOWNWARD SLOPING- SRPC

Question 4

Where is LRPC?

Answer 4

LRPC is Vertical

- Unemployment remains at NRU

Question 5

When AD Increases, what happens to Inflation + Unemployment in LR?

Answer 5

Since LRPC is Vertical

• Unemployment remains the Same
• Inflation Increases

Question 6

Why is the SRAS Curve Upward sloping?

Answer 6

In SR- Expected Prices ≠ Actual Prices

Question 7

When in the Philips Curve Downward sloping?

Answer 7

When Expected Inflation ≠ Actual Inflation

Question 8

What does the P.C look like when Expected Inflation = Actual Inflation?

Answer 8

P.C is Vertical

Question 9

Why does Economic Policy affect Output?

Answer 9

Creates Surprise/Unexpected Inflation / Disinflation

Question 10

How does Monetary Expansion lead to Increased Inflation?

Answer 10

Monetary Expansion –> Surprise Inflation –> SR: Increased Y + Employment
– LR: People expect Increasing Inflation to persist –> Expectations catch up to Actual Inflation –> Move up LRPC –> Increased Inflation

Question 11

How do you calculate the Unemployment rate?

Answer 11

Unemployment Rate = NRU – a( Actual Inflation – Expected Inflation )

Question 12

What happens to Unemployment if Actual > Expected?

Answer 12

Unemployment Decreases

Question 13

What causes a Shift in SRPC?

Answer 13

Changes in Expected Inflation

Question 14

How do Supply Shocks affect SRPC?

Answer 14

Directly alter Costs + Prices –> Shift SRAS –> Shift SRPC

Question 15

What does Contractionary Monetary Policy imply with regards to the Cost of Reducing Inflation?

Answer 15

AD Contracts –> Inflation Decreases- move down SRPC
– Unemployment Increases
BUT- Over time: SRPC Shifts Left –> Unemployment back at NRU with Lower Inflation

Question 16

What is the Sacrifice Ratio?

Answer 16

% of Annual Output LOST in process of Reducing Inflation by 1%

Question 17

What are Rational Expectations?

Answer 17

People Optimally use Info. they have- including Info on Gov. Policy when forecasting future
- If People strongly believe C.B will fight Inflation–> People Immediately Lower Expectations

Question 18

What were the Results of Volker + Thatcher Disinflations + suggest a reason why

Answer 18

Costs NOT as large as Predicted- but still High

- May mean: Public did NOT believe Thatcher/Volker when they announced M.P to Reduce Inflation

Question 19

What is Inflation Targeting?

Answer 19

C.B commits to an Inflation target- e.g. 2%

• Avoids people NOT believing C.B
• Consistent Inflation Expectations

Question 20

How is there the possibility of Costless Disinflation?

Answer 20

• Rational Expectations- implies Smaller Sacrifice Ratio
• • However- Gov./C.B must credibly commit to Policy of Low Inflation so:
• People Lower Expectations of Inflation–> so when Actual Inflation Falls sharply- so does Expectations
• • So we stay on LRPC

Question 21

How does a Rise in Oil Prices affect SRPC?

Answer 21

Increased Oil Prices –> Decreased SRAS –> Stagflation–> SRPC Shifts Right- at fixed U- Inflation rises
- If people expect Inflation to Rise in future–> Move up LRPC
Shift in SRAS –> Shift in SRPC