Chapter 14 MACRO

The rational-expectations point of view, in the most extreme case, holds that if policymakers are credibly committed to reducing inflation, and rational people understand that commitment and quickly lower their inflation expectations, then the sacrifice ratio will be approximately:

0

Assume that the sacrifice ratio for an economy is 4. If the central bank wishes to reduce inflation from 10 percent to 5 percent, this will cost the economy ______ percent of one year's GDP.

20

Advocates of the rational-expectations approach predict that a credible policy to lower inflation will ______ the sacrifice ratio.

Lower

In the sticky-price model, if no firms have flexible prices, the short-run aggregate supply schedule will:

be horizontal.

Phillips curve

derived from the SRAS curve § states that inflation depends on § expected inflation § cyclical unemployment § supply shocks § presents policymakers with a short-run tradeoff between inflation and unemployment

According to the imperfect-information model, when the price level rises by the amount the producer expected it to rise, the producer:

does not change production

The tradeoff between inflation and unemployment does not exist in the long run because people will adjust their expectations so that expected inflation:

equals the inflation rate.

According to the sticky-price model, other things being equal, the greater the proportion, s, of firms that follow the sticky-price rule, the ______ the ______ in output in response to an unexpected price increase.

greater; increase

§ the natural rate hypotheses

states that changes in aggregate demand can affect output and employment only in the short run

In the case of demand-pull inflation, other things being equal:

the inflation rate rises but the unemployment rate falls.

(Exhibit: AD-AS Shifts) Starting from long-run equilibrium at A with output equal to and the price level equal to P1, if there is an unexpected monetary contraction that shifts aggregate demand from AD1 to AD3, then the short-run nonneutrality of money is represented by the movement from:

A to G

(Exhibit: Short-Run Phillips Curve) As the short-run Phillips curve shifts from A to B to C to D, policymakers face:

a lower rate of inflation for any level of unemployment.

If the equation for a country's Phillips curve is π = 0.02 - 0.8(u - 0.05), where π is the rate of inflation and u is the unemployment rate, what is the short-run inflation rate when unemployment is 4 percent (0.04)?

above 2 percent (0.02)

Inflation inertia is represented in the aggregate supply-aggregate demand model by continuing upward shifts in the:

aggregate demand and short-run aggregate supply curves.

§ rational expectations

based on all available information § implies that disinflation may be painless

The assumption of adaptive expectations for inflation means that people will form their expectations of inflation by:

basing their opinions on recently observed inflation.

According to the Phillips curve, other things being equal, inflation depends positively on:

expected inflation.

The short-run aggregate supply curve is drawn for a given:

expected price level.

Both models of aggregate supply discussed in Chapter 14 imply that if the price level is lower than expected, then output ______ natural rate of output.

falls below the

According to the natural-rate hypothesis, output will be at the natural rate:

in the long run

Along an aggregate supply curve, if the level of output is less than the natural level of output, then the price level is:

less than the expected price level.

both sticky price and imperfect information model imply that

output rises above its natural rate when the price level rises above the expected price level.

The percentage of a year's real GDP that must be foregone to reduce inflation by 1 percentage point is called the:

sacrifice ratio.

Based on the Phillips curve, unexpected movements in inflation are related to ______, and based on the short-run aggregate supply curve, unexpected movements in the price level are related to ______.

unemployment; output

adaptive expectations

§ based on recently observed inflation § implies "inertia"

hysteresis

§ states that aggregate demand can have permanent effects on output and employment