Question

1. The low-price fashion chain Forever 21 has reached a decision to discontinue operations in Canada. The retailer operates 44 stores in Canada and employs about 2,000 people. Using appropriate diagrams, explain the following.

1. Is there a trade-off between the unemployment rate and the inflation rate in the short run? How can the Phillips curve be used to answer this question?
2. Explain how the aggregate demand and aggregate supply impact the Phillips curve.
3. If the unemployment rate and inflation are both rising, can this be explained by a movement along a given Phillips curve? What must be happening to aggregate demand and aggregate supply? What must be happening to the Phillips curve?
4. If the Bank of Canada continues to take expansionary monetary policy, how will the unemployment rate and inflation be affected? (Use both Phillips curve and AS-AD graphs in your explanation.)
5. Is there a trade-off between the unemployment rate and inflation in the long run? How is the long run aggregate supply curve related to the long run Phillips curve?

Answer 1

Trade off between Unemployment rate and Inflation rate in the short run

The short run Phillips curve shows this trade off between Unemployment rate and inflation rate

The above graph represents short run Phillips curve------

It states that there is an inverse relationship between Inflation rate and unemployment rate.

When inflation rate falls, there is an increase in the unemployment rate and vice versa

In the graph,we find that at inflation rate i%, the unemployment rate is u% ,and as inflation rate falls to i', the Unemployment rate increases to U'

Impact if AD-AS curves on Phillips curve------

Aggregate demand and aggregate Supply Curve represents Equilibrium level of real income ,output and employment in an economy.

In the graph ,we observe that real output y and price level p is determined as per the intersection of both curves at Equilibrium Point E

When Aggregate demand Decreases, the AD Curve shifts leftward and form Equilibrium Point E', at which price level falls to p' and real output Decreases to y'

Impact on Phillips curve due to Decrease in AD--

We find in the graph that with the fall in price level, the rate of inflation falls to i' and consequently the decrease in real output reduces the economic grouth in the form of income, output and employment and finally the unemployment rate rises.

Impact of Expansionary monetary policy on AD-AS and Phillips curve------

EXPANSIONARY MONETARY POLICY

It is policy instruments used by FED when the evonomy undergiong recessionary conditions and is operating within under employment phase, there is low real GDP and national income.

In order to revive economy ,the central bank, increases money supply in the Economy and increases Consumption , Investment Expenditure,that is increasing overall AD.

* Impact on AD-AS

We find that, AD curve shifts rightward die to implementation of Expansionary monetary policy .

The Equilibrium Point E', determines new real gdp y' and increase in price level p'.

* Impact on short run Phillips curve------

.

We observe that due to increase in AD (under expansionary Monetary policy ) , the increase in price level increases the rate of inflation to i' and inturn decreases unemployment to U'

The resaon being, increase in real gdp and employment leads to reduction in unemployment rate.

long run AD-AS and Phillips curve------

In the long run, the real gdp is equal to potential gdp level because it is determined where shirt run AS, AD and long run AS curves intersect at one Equilibrium point E

We fond that LRAS is a vertical line which intersects SRAS and AD curves and determines Equilibrium level of output equal to potential output.

*long run Phillips curve------

See the graph below----

Long run Phillips curve is a vertical line ( NAIRU), that represents Natural rate of unemployment.It states that there is no tradeoff between inflation rate and unemployment rate in the long run.