Phillip’s curve and AD-As Model. Use assumptions below to set up an initial point denoted as...

Phillip’s curve and AD-As Model. Use assumptions below to set up an initial point denoted as the point A for a, b, and c. for each of the following draw an AD/AS diagram and a corresponding Phillip’s curve assuming the following.

Suppliers produce more goods and services when price increases

Actual GDP is 20,000

Full employment GDP is 15,000

The natural rate of unemployment is 5.5% and actual unemployment is4%

Discretionary policies are needed because wages are sticky

Actual unemployment and output fluctuate around 5.5% and 15,000 respectively.

Show in both diagrams the effect of an increase in income tax on price level, output, unemployment and inflation (Hint: Fiscal Policy)

Show both in diagrams the effect of the Quantitative Easing (QE) on price level, output, unemployment and inflation) (Hint: Monetary Policy)

Show both diagrams the effects of a decrease in expected price levels during the business cycle.

Solutions

Expert Solution

?a) Increase in open market sales leads means contractionary monetary policy. This leads to reduction in AD which shifts to the left. This leads to reduction in output and price.

Reduction in output means increase in unemployment. This inverse relation between unemployment and price is reflected in the Philip’s curve.

b) The price shock led to reduction in aggregate supply as production costs increased. Thus, the AS curve shifted to the left. This resulted in reduction in output but increase in price. Thus, the tradeoff between inflation and unemployment was gone.

This means that both unemployment and price increased. Thus, the Philip’s curve shifted out to the right. At 5% natural unemployment rate now there is greater inflation in the economy.

c) A technology boom shifts out the AS curve to the right. This leads to reduction in price and increase in output. This implies positive relation between price and unemployment.

This occurs because the Philip’s curve shifts in to the left. Due to the technology boom, the inflation ate at 5% natural rate of unemployment is now lower than before

Rahul Sunny answered 1 year ago

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