Question

Q2. Suppose that workers and business firms believe that the Fed will take action to prevent demand shocks from causing a permanent change in the inflation rate.

(a) Will the short-run Phillips Curve shift when a change in the output ratio changes the inflation rate?

(b) For workers and business firms to continue to hold these expectations, explain what actions the Fed must take when there is a positive demand shock and when there is a negative demand shock.

Q3.Suppose that natural real GDP is constant. For every 1 percent increase in the rate of inflation above its expected level, firms are willing to increase real GDP by 1 percent. The expected rate of inflation in the current period equals the actual rate of inflation in the previous period. Initially the output ratio is 100 and the actual and expected inflation rates equal 2 percent.

(a) Compute points on the short-run Phillips Curve when the inflation rate equals 0, 1, 2, 3, 4, and 5. Graph the short-run Phillips Curve.

(b) What is the growth rate of nominal GDP in the economy? Suppose that due to baby boomers becoming eligible for Medicare, there is a permanent increase in the growth rate of the federal government’s spending. That increase causes the growth rate of nominal GDP to accelerate to 4 percent.

(c) Use the short-run Phillips Curve to explain what the rate of inflation and the output ratio are in the first period after the increase in the growth rate of nominal GDP.

(d) Explain what the inflation rate is in the long run, given the increase in the growth rate of nominal GDP, and describe how the economy adjusts to the long-run equilibrium.

Answer 1

Q 2

SHORT-RUN PHILLIPS CURVES (SP CURVE):

It is a schedule associated to real gross domestic product to the inflation rate achieveble at a given fixed anticipated inflation rate is identified as the short-run philips curve

A)

CHANGE IN THE SHORT-RUN PHILLIPS CURVE WHEN THE OUTPUT RATION CHANGES THE RATE OF INFLATION:

If employees and business companies consider that the fed will take necessary actions to alert a shock demand from leading to any permenant variation in the rate of inflation rates are only momentary.hence any output change ratio that increases or minimizes the inflation rate that does not consequence in a variation in the anticipated rate of inflation.Given that the projected rte of inflation does not vary there is lack of change in the short-run phillips curve.

b)

ACTIONS THAT ARE TO BE TAKEN BY FED WHEN THERE IS POSITIVE SHOCK DEMAND AND WHEN THERE IS NEGATIVE SHOCK DEMAND:

For employees and business companies to persist to hold these expectations,the fed must take necessary actions to diminish the nominal growth of gross domestic products to its original stage when there is a optimistic demand shock,and to raise the growth of nominal gross domestic product to its original level when there is a pessimistic demand shock

if the fed fail to perform,then theshock demand could consequence in a everlasting variation in the rate of infation which will lead the employees and businesses to discard their original