Question

1a) What is the sacrifice ratio?

1b) Can you show on a (graph) using Phillips curves why dis-inflationary monetary policy might cause a period of high unemployment and low output in the short-run? What could make this transition period faster? Is it possible not to experience this transition period?

1c) How will the economy adjust in the long-run? (Show on Graph)

Answer 1

Sacrifice ratio measures rising and falling inflation effects on national production amd output.

Disinflationary monetary policy leads to high interest rates which reduce liquidity in market and corporate borrowing and thus layoffs begin duebto lower cash flow causing high unemployment and thus aggregate demand and consumption both fall which leads to lower prices and lower inflation subsequently. Transition period is possible and can be made faster by execution of timely policy and avoiding implementation lags and through other counter cyclical measures. ​​​​​​

In long run however economy will adjust itself througj expansionary monetary policy once inflation hits bottom or when real GDP shrinks considerably to bring inflation back and achieve equilibrium.

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