Macroeconomics Chapter 17

In the​ figure, expected inflation is initially at​ 1.5%. When expected inflation increases to​ 4.5%, which of the following will​ occur?

1) To have 3.5% unemployment rate, inflation wold be 7.5% 2) Unemployment reaches the natural rate of 5% 3) At the natural rate of unemployment, inflation is 4.5%ANSWER: All of the Above At this higher expected inflation​ rate, the real wage​ rose, causing some workers to lose their jobs. The​ economy's equilibrium returned to the natural rate of unemployment at​ 5%, but now with an inflation rate of​ 4.5% instead of​ 1.5%.

Assume that inflation expectations increase. What will happen to the​ short-run Phillips​ curve? Use the line drawing tool to show the impact of an increase of inflation expectations on the Phillips curve. Carefully follow the instructions​ above, and only draw the required objects. An increase in inflation expectations will cause the inflation rate to ___________ at all levels of unemployment.

1. Draw a SRPC to the right of the original and label it "SR Phillips Curve" -Increase in inflation --> SRPC shifts right 2. Increase

Point _____ on the Phillips curve graph represents the same economic situation as point B on the aggregate demand and aggregate supply graph.

1. e 2. d

Real Business Cycle Theory

A macroeconomic model that focuses on real, rather than monetary, causes of the business cycle.

In the real business cycle model, which of these best explains an increase in real GDP above the full-employment level?

A positive technology shock

Which of these factors can cause the natural rate of unemployment to change?

Demographic Changes Since younger lower skilled workers have higher rates of unemployment a shift in the age structure of the labor force can cause the natural rate of unemployment to change.

Rational expectations

Expectations formed by using all available information about an economic variable.

Why​ doesn't the Phillips curve represent a permanent​ trade-off between unemployment and inflation in the long​ run?

In the long​ run, aggregate supply is vertical.

The Phillips curve was developed by A.W. Phillips in 1957 and shows the relationship between unemployment and inflation. The​ curve, shown at the​ right, indicates what type of relationship between the two​ variables?

Inverse relationship

Which of the following statements concerning the Phillips curve is​ correct?

Many economists and policymakers in the 1960s viewed the Phillips curve as a structural relationship.

The​ short-run trade-off between the rate of inflation and the unemployment rate is best represented​ by:

Phillips curve

According to real business cycle theory, a major source of fluctuations in economic activity is __________.

Shocks to technology

Such views of the​ trade-off between inflation and unemployment might have existed in the 1960s because the Phillips curve was widely viewed as Such views are rare today because

Stable in the long run there is no tradeoff between inflation and unemployment.

Rational Expectations Theory

The hypothesis that business firms and househlds expect monetary and fiscal policies to have certain effects on the economy and take, in pursuit of their own self interests, actions which make these policies ineffective at changing real output.

Natural Rate of Employment

The normal rate of unemployment, consisting of frictional unemployment and structural unemployment.

Nonaccelerating inflation rate of unemployment (NAIRU)

The unemployment rate at which the inflation rate has no tendency to increase or decrease.

How can the Fed fight a combination of rising unemployment and rising inflation?

These goals are conflicting and cannot be addressed simultaneously.

Disinflation

a reduction in the rate of inflation

Which of the following statements is ​correct?

a. In the long run, a higher or lower price level has no effect on real GDP. b. In the long run, a higher or lower inflation rate has no effect on the unemployment rate. c. In the long run, the Phillips curve is a vertical line at the natural rate of unemployment (CORRECT ANSWER: All of the above)

If actual inflation is higher than expected​ inflation, the

actual real wage is less than the expected real​ wage: unemployment falls. If actual inflation is higher than expected​ inflation, actual real wages in the economy will be lower than expected real wages. As a​ result, many firms will hire more workers than they had planned. Unemployment falls.

The short−run Phillips curve​ is:

downward sloping

The labor market may take a long time to adjust to economic growth due to __________.

excess capacity in production

There is a different​ short-run Phillips curve for every level of the​ ___________ inflation rate. The inflation rate at which the​ short-run Phillips curve intersects the​ long-run Phillips curve equals the​ ___________ inflation rate.

expected; expected

When aggregate demand increases, unemployment will usually __________ and inflation will __________.

fal, rise

According to rational expectations theory, any announced policy change will:

have no impact on output

According to real business cycle theory, shifts in aggregate demand:

have no impact on real GDP

What four tools can the Fed use to achieve its monetary policy goals?

he discount rate, reserve requirements, open market operations, and interest on reserves. The fed CANNOT control the inflation rate

It is inconsistent to believe that the​ long-run aggregate supply curve is vertical and the​ long-run Phillips curve is downward sloping because

in order for the​ long-run Phillips curve to be downward​ sloping, changes in the price level​ (inflation) would have to affect the unemployment rate in the long​ run, which does not happen with a vertical​ long-run aggregate supply curve.

If the unemployment rate is below the natural​ rate, the inflation rate tends to​ ___________, and​ eventually, the​ short-run Phillips curve will shift​ _______. The concept of a nonaccelerating inflation rate of unemployment​ (NAIRU) helps us to understand why in the long​ run, the Federal Reserve

increase; up can affect the inflation rate but not the unemployment rate.

The long-run Phillips curve __________.

is vertical at the natural rate of unemployment

Consider the​ long-run Phillips curve and the​ short-run Phillips curve in the graph at right. A movement from point A to point C could be caused by

long-run effects of contractionary monetary policy. If the Federal Reserve used contractionary policy to push​ short-run equilibrium to a point such as B​, where the unemployment rate is above the natural​ rate, the inflation rate would decrease. If​ short-run equilibrium remained above the natural rate long​ enough, the​ short-run Phillips curve would shift down as workers and firms adjusted to the​ new, lower inflation rate. Only at a point such as C​, where the unemployment rate is equal to the natural​ rate, will the inflation rate be stable. We can conclude that in the long​ run, the Federal Reserve can affect the inflation rate but not the unemployment rate.

Countries that grant their central banks higher degrees of independence from the political process are more likely to have:

lower inflation

If high unemployment continues to be a problem for several years it is possible that the:

natural rate of unemployment may increase. Workers who remain unemployed for years lose skill sets and marketability and become increasingly more unlikely to find work.

If workers and firms have rational expectations and wages and prices adjust quickly, an expansionary monetary policy will result in higher inflation and

no change in the unemployment rate

Monetary stimulus designed to increase aggregate demand would have __________ on real output according to real business cycle theory.

no impact Changes in economic activity are only attributable to real changes in technology or productivity and not changes in the money supply.

The output gap is the difference between __________.

potential GDP and actual GDP

The theory that workers will use all available information to form forecasts of the future expected inflation is known as:

rational expectations.

Economists during the early 1960s thought of the Phillips curve as a​ "policy menu" because they thought that the Phillips curve They __________ to think of the Phillips curve as a​ "policy menu."

represented a structural relationship in the economy that would not change as a result of policy changes. were not correct

According to Milton Friedman, differences between the actual and expected inflation rates could lead the actual unemployment rate to __________.

rise above or fall below the natural rate

As expectations of inflation​ increase, the​ short-run Phillips curve will ___________ .If inflation increases beyond expectations of​ inflation,

shift to the rights the real wage paid by employers and received by workers will decrease.

Consider the​ long-run Phillips curve and the​ short-run Phillips curve in the graph at right. A movement from point A to point B could be caused by

short run effects of contractionary monetary policy. If the Federal Reserve were to attempt to use contractionary monetary policy to push​ short-run equilibrium to a point such as B​, where the unemployment rate is above the natural​ rate, the result would be a movement down the​ short-run Phillips curve with decreasing inflation.

A Phillips curve is a curve showing the __________.

short-run relationship between the unemployment rate and the inflation rate

A relationship based on consumer and firm behavior that remains consistent for long periods of time is known as a:

structural relationship

Friedman's assumptions

the LRAS and the LRPC are both vertical. Inflation doesn't impact Unemployment

​If, in the long​ run, real GDP returns to its potential​ level, then in the long​ run,

the Phillips curve is vertical. Natural rate of unemployment The unemployment rate that exists when the economy is at potential GDP.

Milton Friedman argued that the Phillips curve did not represent a permanent​ trade-off between unemployment and​ inflation, since Friedman defined the​ "natural rate of​ unemployment" as the

the​ long-run Phillips curve is​ vertical, there is no​ trade-off between unemployment and inflation in the long run. the unemployment rate that exists when the economy produces potential GDP.

The natural rate of unemployment is the __________.

unemployment rate that results when the economy produces the potential level of real GDP

If the Fed wants to move from a point on the​ short-run Phillips curve representing high unemployment and low inflation to a point representing lower unemployment and higher​ inflation, then it should

use expansionary monetary policy expansionary monetary policy deals with recessions (high unemployment + low inflation = recession)

Most economists agree that in the long run there is no tradeoff between inflation and unemployment which means the long-run Phillips curve is:

vertical