Question

16. The natural rate of unemployment
(x) varies over time, but can’t be changed by the government.
(y) is the unemployment rate that the economy tends to move to in the long run.
(z) does not depend on the rate at which the Fed increases the money supply.
A. (x), (y) and (z)
B. (x) and (y) only
C. (x) and (z) only
D. (y) and (z) only
E. (z) only

17. According to the natural rate hypothesis (Friedman and Phelps), in the short run the economy will move to
a point on the Phillips curve where the unemployment rate is higher if,
A. the inflation rate decreases.
B. the government decreases taxes.
C. the Fed decreases the money supply.
D. All of the above
E. A and C, only

Answer 1

16. The natural rate of unemployment can change over time if the government takes steps to chage structural or frictional unemployment. If the goverment increases the minimum wage, it becomes more attractive to work than living on unemployment benefits. This way government can change the long run unemployment that persist in the economy and consequently the natural rate of unemployment. Since natural rate unemployment is the rate the economy tends to move in the long run. When Fed increases the money supply, it increases the inflation and reduces the unemployment but only in short run. So changes in money supply does not affect natural rate of unemployment. So the correct answer is

D. (y) and (z) only.

17. According to natural rate hypothesis, there is an inverse relation between unemployment rate and inflation. If unemployment rate, it means the inflation rate must have reduced. In the long run, the economy tends to move towards the natural rate of unemployment . So anything that reduces inflation or output , umemployment rate will be higher in short run.

When governmnet decreases taxes, it gives more disposable income in the hands of people to spend. Demand of goods will increases and hence more demand of workers to produce those goods. This musr reduce unemployment

When Fed decreases money supply, it leaves less money in hands of public. The demand of goods will fall and consequently output will fall. Less workers will be needed to produce less goods. Un employment will be higher.

Hence In the short run, economy will be at a point where unemployment rate will be higher if inflation reduces and Fed decreases money supply. The correct answer is

E. A and C, only