Econ Ch 16

If the monetary authorities decide to increase the nominal money supply by 10% when the economy is at its full-employment level of output, in the long run the aggregate price level increases by ________ and real GDP ________.

10%; returns to the potential level of output

The figure shows three different short-run Phillips curves and one long-run Phillips curve for an economy. SRPC0 is the short-run Phillips curve when the public expects 0 percent inflation. SRPC3 is the short-run Phillips curve when the public expects 3 percent inflation. SRPC6 is the short-run Phillips curve when the public expects 6 percent inflation. When the expected inflation rate is 0 percent, what level of inflation is required to keep unemployment at 3 percent?

3 percent

The figure depicts two different short-run Phillips curves. SRPC0 is the short-run Phillips curve when the public expects 0 percent inflation. SRPC3 is the short-run Phillips curve when the public expects 3 percent inflation. When the expected inflation rate is 0 percent, what level of unemployment is associated with 2 percent inflation?

4 percent

The figure depicts two different short-run Phillips curves. SRPC0 is the short-run Phillips curve when the public expects 0 percent inflation. SRPC3 is the short-run Phillips curve when the public expects 3 percent inflation. When the expected inflation rate is 3 percent, what level of inflation is associated with 4 percent unemployment?

5 percent

The figure depicts two different short-run Phillips curves. SRPC0 is the short-run Phillips curve when the public expects 0 percent inflation. SRPC3 is the short-run Phillips curve when the public expects 3 percent inflation. When the expected inflation rate is 3 percent, what level of unemployment is associated with 3 percent inflation?

6 percent

The figure shows three different short-run Phillips curves and one long-run Phillips curve for an economy. SRPC0 is the short-run Phillips curve when the public expects 0 percent inflation. SRPC3 is the short-run Phillips curve when the public expects 3 percent inflation. SRPC6 is the short-run Phillips curve when the public expects 6 percent inflation. When the expected inflation rate is 3 percent, what level of inflation is required to keep unemployment at 3 percent?

6 percent

The figure shows three different short-run Phillips curves and one long-run Phillips curve for an economy. SRPC0 is the short-run Phillips curve when the public expects 0 percent inflation. SRPC3 is the short-run Phillips curve when the public expects 3 percent inflation. SRPC6 is the short-run Phillips curve when the public expects 6 percent inflation. When the expected inflation rate is 6 percent, what level of inflation is required to keep unemployment at 3 percent?

9 percent

The figure shows three different short-run Phillips curves. Which of the following statements correctly describes a shift from SRPC0 to SRPC 2?

A negative supply shock has caused the level of inflation associated with each level of the unemployment rate to become higher than before.

Part 1: Assume the inflation rate is high in the economy. Draw the initial economy in long-run equilibrium, Label the short-run demand curve AD1, the short-run supply curve SRAS1 and the long-run supply curve LRAS1. Be sure to plot the initial equilibrium using the double drop line tool and label it E1. Part 2: Now demonstrate the long run price level adjustment to a money supply increase. Label the curves you draw accordingly. Then plot the resulting equilibrium using the double drop line tool and label it E2.

Assume the inflation rate is high in the economy

Below is a short-run Phillips curve (SRPC1) with inflation expectations of 5% and the natural rate of unemployment of 6%. Show what happens when inflation expectations fall to 3%. Label the new short-run Phillips curve SRPC2.

Below is a short-run Phillips curve

The diagram shows the short-run Phillips curve (SRPC0) of the country of Brittania in 2005. Part 1: In 2006 the country experienced a very substantial increase in the price of oil in the global market. Since Brittania depends on imported oil, the oil shock sharply increased the cost of production and, hence, prices in Brittania. Draw the short-run Phillips curve for Brittania after the oil shock. Label this curve SRPC1. Part 2: By the end of 2007, Brittania experienced a substantial increase in productivity due to increased computerization and a general technological boom. These led to substantial cost and price reductions in 2008. Draw the short-run Phillips curve for Brittania after the productivity improvement. Label this curve SRPC2.

Brittania

Draw a short-run Phillips curve (SRPC1) assuming inflation expectations are zero and the natural rate of unemployment equal to 6%. Part 1: Suppose the economy is currently at an unemployment rate of 6%. Plot this point on the Phillips curve and label this point A. Part 2: Now suppose the monetary authorities try to decrease the unemployment rate to 4%. Illustrate what will happen in the long run if the monetary authorities are successful and if the expectations of inflation rise. Plot the new unemployment rate and label that point B.

Draw a short-run Phillips curve

The neighboring countries of Eastland and Westland have the same natural rate of unemployment of 6%. While they have many economic and cultural similarities, they differ in one important aspect. Eastland has had long experience with substantially high inflation rates, while inflation has always been very moderate in Westland. Consequently, in Eastland, any increase in actual inflation is likely to result in a corresponding increase in expected inflation much quicker than in Westland. Using the line drawing tool, draw two reasonable short-run Phillips curves: one for Eastland and the other for Westland. Label the curve for Eastland SRPC1 and the curve for Westland SRPC2.

Eastland and Westland

Which of the following accurately describes disinflation?

It is the process of bringing down the inflation that has become embedded in expectations.

The natural rate of unemployment in the country of Kanto is 6%. Assuming expected inflation to be zero, the equation for the short-run Phillips curve is given to be: Inflation rate = -2 x (unemployment rate - 6). Using the above formula, plot the inflation rate corresponding to the unemployment rates: 1, 2, 3, 4, 5, and 6% to draw the short-run Phillips curve (SRPC). Use the infinite line tool to draw the long-run Phillips curve (LRPC).

Kanto

At the beginning of 2009, the small country of Luthania was at the full employment level, producing at the potential GDP level of $100 billion. The economy was at the equilibrium where the price level was 5. In May, 2009, the central bank of Luthania increased the money supply which shifted the aggregate demand curve from AD1 to AD2. The new short-run equilibrium was reached at point E2 where the level of GDP increased to $120 billion. Also, the price level rose to 6. According to the classical model, what should happen in the country of Luthania following the increase in aggregate demand? Demonstrate this by using the drawing tools to shift the aggregate demand, the short-run aggregate supply and/or the long-run aggregate supply curve(s). Label the new curve(s) AD2, SRAS2 and/or LRAS2. Using the double drop line tool, plot the new equilibrium point and label it E3.

Luthania

In the country of Northland the natural rate of unemployment is 6% and the expected inflation rate is 8%.The accompanying graph shows the long-run Phillips curve (LRPC1) and the short-run Phillips curve (SRPC1) with an 8% expected inflation rate for Northland. Part 1: Suppose that the central bank of Northland wants to hold the inflation rate at 8%. Plot a point that shows the combination of the unemployment rate and actual inflation rate. Label the point A. Part 2: An aggregate demand shock resulting from a massive tax cut raises the expected inflation rate to 10%. The natural rate of unemployment remains at 6%. Plot the new short-run Phillips curve for the following unemployment rates: 1, 2, 3, 4, 5, 6, 7, 8, 9 and 10%. Label the new curve SRPC2. Part 3: Now suppose that a supply shock resulting from an increase in the price of oil raises the expected inflation rate to 10% and increases the natural rate of unemployment to 8%. Plot the new short-run Phillips curve for the following unemployment rates: 1, 2, 3, 4, 5, 6, 7, 8, 9 and 10%. Label this curve SRPC3. Using the line tool, draw the new long-run Phillips curve and label it LRPC2.

Northland

The accompanying graph shows a long-run Phillips curve (LRPC) and short-run Phillips curve (SRPC1). The economy is currently at the NAIRU of 5% unemployment and 5% annual inflation. Suppose that the central bank causes a one-time decrease in the money supply and shifts aggregate demand to the left. The new unemployment rate is now 6% and the new inflation rate is 4%. Part 1: In the graph identify a point on the short-run Phillips curve that might correspond to this monetary policy. Label this point E2. Part 2: In the graph illustrate the long-run adjustment to this policy.

Part 2: In the graph

Sketch a short-run Phillips Curve (SRPC1) assuming the natural rate of unemployment is 6% and inflation expectations are 0%. Now assume that the price of oil increases and inflation expectations are still 0%. Show what happens to the short-run Phillips curve. Label the new curve SRPC2.

Sketch a short-run Phillips Curve

What is the eventual outcome when a government prints money in an attempt to raise revenue through seignorage?

The amount of seignorage collected from each unit of currency will continually diminish as the price level rises.

What is measured on the vertical axis of a graph depicting the short-run Phillips curve?

The inflation rate

Which of the following statements is TRUE?

The long-run Phillips curve is vertical at the NAIRU.

Which of the following statements is TRUE?

Under conditions of high inflation, prices of intermediate goods adjust more rapidly than under conditions of low inflation.

The figure depicts two different short-run Phillips curves. SRPC0 is the short-run Phillips curve when the public expects 0 percent inflation. SRPC3 is the short-run Phillips curve when the public expects 3 percent inflation. Which of the following statements is TRUE?

When the actual inflation rate equals the expected inflation rate, unemployment will be at 6 percent.

The figure depicts two different short-run Phillips curves. SRPC0 is the short-run Phillips curve when the public expects 0 percent inflation. SRPC3 is the short-run Phillips curve when the public expects 3 percent inflation. Which of the following statements is TRUE?

When the short-run Phillips curve shifts from SRPC0 to SRPC3, the level of inflation associated with each level of the unemployment rate increases.

A downward shift of the short-run Phillips curve could arise from

a decrease in the expected inflation rate.

The accompanying graph shows a long-run Phillips curve (LRPC) and short-run Phillips curve (SRPC1). The economy is currently at the NAIRU of 5% unemployment and 3% annual inflation. Suppose that the central bank causes a one-time increase in the money supply and shifts aggregate demand to the right. The new unemployment rate is now 4% and the new inflation rate is 4%. Part 1: In the graph identify a point on the short-run Phillips curve that might correspond to this monetary policy. Label the point E2. Part 2: Illustrate the long-run adjustment to this policy. Identify this new inflation rate at the NAIRU and label the point E3.

accompanying graph shows

The long-run Phillips curve is vertical at the NAIRU because:

any unemployment rate below the NAIRU will lead to ever-accelerating inflation.

Hyperinflation is the direct result of

governments printing money as a means of generating revenue.

Assume that workers and businesses are sensitized to inflation and are quick to raise wages and prices in response to changes in the money supply. This implies that if inflation is _______ and there are ______ adjustments of wages and prices of intermediate goods.

high; quick

The downward slope of the short-run Phillips curve suggests that

higher inflation rates are associated with lower unemployment rates.

The inflation tax is equal to

inflation multiplied by the demand for money.

The cost of disinflation is the

loss of real GDP in the process.

(Figure: The Great Disinflation) Refer to the information in the figure. In the early 1980s, the inflation rate was beaten down by the Federal Reserve's tight monetary policy. In the short run this policy led to a ______ level of actual output and a ______ rate of unemployment.

low; high

Figure: The Great Disinflation Reference: Ref 16-8 (Figure: The Great Disinflation) Refer to the information in the figure. In the early 1980s, the inflation rate was beaten down by the Federal Reserve's tight monetary policy. In the short run this policy led to a ______ level of actual output and a ______ rate of unemployment.

low; high

To bring disinflation to an economy, policy makers must:

lower expectations about inflation.

When the Treasury Department borrows from the public to finance the government's purchases of goods and services and the Fed buys the debt back from the public in the form of Treasury bills, it is known as:

monetizing the debt.

Part 1: Assume the inflation rate is high in the economy. Draw the initial economy in long-run equilibrium, Label the short-run demand curve AD1, the short-run supply curve SRAS1 and the long-run supply curve LRAS1. Be sure to plot the initial equilibrium using the double drop line tool and label it E1. Part 2: Now demonstrate the long run price level adjustment to a money supply increase. Label the curves you draw accordingly. Then plot the resulting equilibrium using the double drop line tool and label it E2.

money supply increase

Inflation doesn't reduce purchasing power if

nominal wages rise at the same rate as prices.

Figure: AD-AS Reference: Ref 16-3 (Figure: AD-AS) Refer to the AD-AS diagram. Suppose the economy starts at E1 and moves to E2, where AD2 intersects SRAS1. Now, suppose that the SRAS1 will shift to SRAS2, because:

nominal wages rise in the long run.

Figure: Classical Model of the Price Level Reference: Ref 16-2 (Figure: Classical Model of the Price Level) Refer to the information in the figure. If the central bank increases the money supply such that aggregate demand shifts from AD1 to AD2, according to this classical model, real GDP would:

not change.

Fiat money is

paper money with no intrinsic value.

If a high inflation rate leads people to ______ their money holdings, this may lead to a further increase in the money supply and ______ inflation.

reduce; higher

Seignorage is

revenue generated by the government's right to print money.

Historically, governments have turned to seigniorage to pay their bills when:

the government lacks the will to reduce the budget deficit by raising taxes or reducing spending.

The inflation tax refers to:

the reduction in the real value of money when inflation rises.

Accelerating inflation can be avoided if

the unemployment rate is high enough that the actual rate of inflation matches the expected rate of inflation.

If the economy does in fact have a nonaccelerating inflation rate of unemployment (NAIRU), then

there is no long-run trade-off between inflation and unemployment.

When workers and firms become aware of a rise in the general price level:

they will incorporate higher prices into their expectations of future prices.