Question

In: Economics

a) What is the sacrifice ratio? b) Can you show on a graph using Phillips curves...

a) What is the sacrifice ratio?

b) Can you show on a graph using Phillips curves why disinflationary 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?

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

Solutions

Expert Solution

A) loss/ Decrease of output due to disinflationary policy or due to decrease in inflation.when policy maker try to reduce inflation,as a result of this ,the GDP Decreased.

The ratio of Decreased gdp per 1 percentage point Decrease in inflation is called sacrifice ratio.

B) Phillips curve show relationship between unemployment and inflation.

Downward sloping Phillips curve shows that there is trade off between inflation and unemployment.

As inflation Decreases ,it is associated with Increase in unemployment.

Expection makes this transition period faster.

If people expect that fed will increase interest rate in near future to decrease inflation and believe it. So they will adjust their expectations and thus their nesr future expenditure.This Will automatically Decrease inflation. But This will also result in Increase in Inflation.

C)due to disinflationary policy, economy will be in recession. Higher unemployment and thus excess supply of Labour will result in lower wages ,which Decrease Production cost ,which Increase aggregate supply and gdp will increase and reach at potential GDP.


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