Question

The Phillips curve in the short run and long run

In the year 2023, aggregate demand and aggregate supply in the fictional country of Marjan are represented by the curves AD2023AD2023 and AS on the following graph.

Suppose the natural level of output in this economy is $6 trillion.

On the following graph, use the green line (triangle symbol) to plot the long-run aggregate supply (LRAS) curve for this economy.

Economists have forecast that if the government does nothing and the economy continues to grow at the current rate, aggregate demand in 2024 will be given by the ADAADA curve, resulting in the outcome illustrated by point A. If the government pursues an expansionary policy, aggregate demand in 2024 will be given by the ADBADB curve, resulting in the outcome illustrated by point B.

The following table gives projections for the unemployment rates that would occur at point A and point B. Consider what the rate of inflation would be between 2023 and 2024, depending on whether the economy moves from the initial price level of 102 to the price level at outcome A or the price level at outcome B.

Note: Calculate the inflation rate to two decimal points of precision.

	Unemployment Rate	Inflation Rate
A	6%
B	3%

Based on your answers to the preceding parts, use the black line (plus symbol) to draw the short-run Phillips curve (SRPC) for this economy in 2024. (Note: You will not be graded on any changes you make to this graph.)

-The short-run Phillips curve is   line:

A)At the natural rate of unemployment

B)Representing the tradeoff between unemployment and inflation

C)At the natural level of output

Now consider the long-run effects of this policy. Suppose, in particular, that following implementation of the policy, the aggregate demand curve remains at ADBADB. Designate the long-run equilibrium that would follow such a policy as outcome C.

Going back to the first graph, place the grey point (star symbol) at outcome C.

Because output at point C is_______ the natural level of output, the unemployment rate associated with outcome C is _____ the natural rate of unemployment.

Finally, use the green line (triangle symbol) to draw the long-run Phillips curve (LRPC) on the second graph.

This line is _______ line:

A)At the natural rate of unemployment

B)Representing the tradeoff between unemployment and inflation

C)At the natural level of output

LRAS Outcome C PRICE LEVEL AD 2023 100 HA 0 2 14 16 4 6 8 10 12 OUTPUT (Trillions of dollars)

SRPC A- LRPC INFLATION RATE (Percent) 0 1 7 8 2 3 4 5 6 UNEMPLOYMENT RATE (Percent)

Answer 1

When Unemployment rate= 6%

Inflation rate= ((104-102)/102)*100= 1.96%

When Unemployment rate= 3%

Inflation rate= ((105-102)/102)*100=2.94%

The short-run Phillips curve is   line:

B)Representing the tradeoff between unemployment and inflation

Reason- Short run Philips curve shows negative relationship between Inflation and unemployment rate.

Draw point C on ADb at $6 trillion of output. As $6 trillion is natural level of output so long run equilibrium occurs at that point.

Because output at point C is_equal to_ the natural level of output, the unemployment rate associated with outcome C is _equal to_ the natural rate of unemployment.

This line is __VERTICAL___ line:

A)At the natural rate of unemployment

Reason- in the long run Philips Curve is vertical and does not exhibit negative relationship between inflation and unemployment and is at the natural rate of unemployment.