Question

Explain the following :

1. Short run tradeoff (negative relationship) between unemployment & inflation.
2. policy is not efficient in the LR.
3. Money supply curve is vertical.
4. Expenditure multiplier + Tax multiplier = 1.

Answer 1

Ans- firstly we came on Ist statement short run tradeoff b/w unemployment and inflation.

   In short run there is inverse relation of inflation with the unemployment, increase in inflation leads to decrease in unemployment and increase in unemployment lead to decrease in inflation. there are negative effect of unemployment for inflation and positive effect on real GDP. For faster economic growth in the short-run, we experience higher inflation and lower unemployment.

Now 2nd statement, policy is not efficient in LR.

Monopolistic competition not efficient in long run. The firm’s profit maximizing output is less than the output associated with minimum average cost. In a monopolistic competitive market, the demand curve is downward sloping. In the long run period this leads to excess capacity.

3rd statements, money supply curve is vertical,

money supply curve is vertical because of it does not depend on interest rate, it depends on Fed policy.The money supply curve is vertical at the quantity of the money supply, not upward sloping or downward sloping.

4th statement, Expenditure multiplier+Tax multiplier =1

For proveing this,

We know marginal prosperity to consume=(change in spending/change in income)

MPS=1-MPC

Expenditure multiplier =1/(1-MPC)

Tax multiplier=-MPC/MPS

Now we can say tax multiplier=-MPC/(1-MPC)

Now Expenditure multiplier+Tax multiplier

={1/(1-MPC) +(-MPC/1-MPC) }

=(1-MPC) /(1-MPC)

=1

Proved.