Question

TRUE OR FALSE

a) Suppose workers are not very sensitive to unemployment. The result will be that inflation will jump a lot every time inflation changes.

b) If in short-run equilibrium inflation is greater than expected inflation, then it must be true that output is less than potential output.

c) The economy may be away from its medium-run equilibrium for a while because actual inflation rates take a while to adjust.

d)Suppose the economy starts from the (potential output, expected inflation) point. A leftward shift of either AD or AS opens a recessionary output gap, which means higher inflation if it is AS that shifted.

e) Suppose the economy starts from the (potential output, expected inflation) point. A shock that increases the natural level of output (and changes nothing else) leads to lower inflation in the short run. Short-run output rises by the same amount as the increase in the natural level of output.

Answer 1

(a) When the workers are not very sensitive to inflation which means when inflation increases they don't demand higher wages as a result the inflation doesn't increases further.

So the statement that inflation will jump a lot every time inflation changes is false.

(b) When the short run equilibrium inflation is higher than expected inflation which means workers are supplying their labor at lower inflation rate in that case they end up supplying more labor which leads to the output greater than the potential output.

So the statement is false.

(c) As mentioned in above part when the expected inflation and actual inflation varies the output is away from its potential or medium run equilibrium output.

So the statement that the output may be away from its medium run equilibrium output because inflation takes a while to adjust is true.

(d) Starting from potential output and expected inflation when the AS curve shifts leftwards which means the supply has decreased while the demand is still the same. As a result the price in the economy will rise to restore the equilibrium, since demand is higher than supply.

So the statement that inflation will be higher if it is AS that has shifted leftwards is true.

(e) A shock that leads to a increase in natural level of output which causes the short run inflation to decrease. But given the expected inflation of workers they will supply their labor based on expected inflation which is higher than the short run inflation as a result they will supply less labor.

So the increase in output will be less than the increase in the natural level of output.

So the statement that output increases by the same amount as the natural level of output is false.