Econ Chapter 35

Which has a lower unemployment, an economy valued at $1 trillion or one valued at $2 trillion?

$1 trillion, because a higher output is associated with a higher workforce meaning a lower unemployment.

T or F:An adverse supply shock, such as an increase in the price of imported oil, shifts the Phillips curve upward and makes the inflation-unemployment trade-off less favorable.

True

T or F:An increase in aggregate demand temporarily reduces unemployment, but after people raise their expectations of inflation, unemployment returns to the natural rate.

True

T or F:An increase in price expectations shifts the Phillips curve upward and makes the inflation-unemployment trade-off less favorable.

True

T or F:If people have rational expectations, an announced monetary contraction by the Fed that is credible could reduce inflation with little or no increase in unemployment.

True

T or F:In the long run, the unemployment rate is independent of inflation, and the Phillips curve is vertical at the natural rate of unemployment.

True

T or F:In the short run, an increase in aggregate demand increases prices and output and decreases unemployment.

True

T or F:The natural-rate hypothesis suggests that, in the long run, unemployment returns to its natural rate, regardless of inflation.

True

T or F:When unemployment is below the natural rate, the labor market is unusually tight, putting pressure on wages and prices to rise.

True

What is Friedman and Phelps Unemployment Equation?

Unemployment Rate = Natural rate of unemployment - (Actual Inflation - Expected Inflation)

What is the natural-rate hypothesis?

Unemployment returns to the natural rate in the long run, regardless of inflation.

What dilemma do policy makers face when they shift the aggregate supply curve?

With a rise in Price and decrease in output along comes both an increase in inflation and unemployment. This is due to firms requiring less workers for a lower output thus increasing unemployment.

What is the Phillips Curve?

a curve showing the short-run relationship between the unemployment rate and the inflation rate

What are rational expectations?

the theory that people optimally use all the information they have, including information about government policies, when forecasting the future

If unemployment is 6 percent and inflation is 5 percent, what is the value of the so-called misery index?

11 percent.

Calculate the inflation rate: Price Level-2020 = 102 Price Level-2025 = 105

2.94%

If the sacrifice ratio is five, how much will output be reduced in order for inflation to be reduced four percentage points? If people have rational expectations, is the sacrifice ratio likely to be larger or smaller than five? Why or why not?

20 percent. Smaller because they will reduce their price expectations more quickly, shifting the Phillips curve to the left.

Who was the economist that wrote the article "The Relationship between Unemployment and the Rate of Change of Money Wages in the United Kingdom, 1861-1957"?

A.W Phillips

Which way does the short-run Phillips curve shift when there is an adverse aggregate supply shock such as an increase in the price of imported oil? Why?

Aggregate supply shifts left showing lower production at each price. Thus, the Phillips curve shifts right (upward) showing more unemployment at each rate of inflation.

What is a supply shock?

An event that directly alters firms' costs and prices, shifting the economy's aggregate-supply curve and, thus, the Phillips curve

Use the model of aggregate demand and aggregate supply to describe why the short-run Phillips curve is negatively sloped.

An increase in aggregate demand increases prices and output along the short-run aggregate-supply curve, which reduces unemployment. Prices have increased, and unemployment has decreased.

Use the model of aggregate demand and aggregate supply to describe why the long-run Phillips curve is vertical.

An increase in aggregate demand increases prices, but output remains at the natural level due to a vertical long-run aggregate-supply curve. Prices have increased, but unemployment remains at the natural rate.

What was the reason that unemployment and inflation were linked toghether?

Because low unemployment was associated with high aggregate demand, which in turn put upward pressure on wages and prices throughout the economy.

If actual inflation exceeds expected inflation, is the unemployment rate above or below the natural rate? Why?

Below because if prices are higher than expected, additional output is produced and additional people are employed, reducing unemployment.

How does disinflation affect the Philips curve?

Contractionary policy moves the economy down along the short-run Phillips curve but in the long-run, expected inflation falls, and the Phillips curve shifts left.

T or F:A sudden monetary contraction moves the economy up a short-run Phillips curve, reducing unemployment and increasing inflation.

False-a sudden monetary contraction moves the economy down a short-run Phillips curve, increasing unemployment and reducing inflation.

T or F:An increase in the money supply increases inflation and permanently decreases unemployment.

False-an increase in the money supply may temporarily decrease unemployment.

T or F:A decrease in unemployment benefits reduces the natural rate of unemployment and shifts the long-run Phillips curve to the right.

False-it shifts the long-run Phillips curve to the left.

T or F:If the sacrifice ratio is four, a reduction of inflation from 9 percent to 5 percent requires a reduction in output of 8 percent.

False-output must be reduced by .

T or F:The Phillips curve illustrates the positive relationship between inflation and unemployment.

False-the Phillips curve illustrates the negative relationship between inflation and unemployment.

T or F:If inflation is 4 percent and unemployment is 6 percent, the misery index is 2 percent.

False-the misery index is 10 percent.

T or F:When actual inflation exceeds expected inflation, unemployment exceeds the natural rate.

False-when actual inflation exceeds expected inflation, unemployment is below the natural rate.

What demand style would an economy strive for in order to achieve consistent growth?

Higher aggregate demand moves the economy to an equilibrium with higher output and a higher price level

How does Expected inflation affect the short-run Phillips curve?

If the Fed moves toward monetary policy it will shift the curve towards higher inflation ,but lower unemployment. While in the long run this number will reach equilibrium when expected inflation rises.

Referring to question 7 above, are the trade-offs between unemployment and inflation that the economy now faces more favorable or less favorable than before the adverse supply shock? Explain.

Less favorable. Now, at each level of unemployment, inflation is higher, or at each rate of inflation, unemployment is higher.

Is the short-run Phillips curve actually a menu of inflation and unemployment combinations permanently available to the policymaker? Why or why not?

No. When inflation increases above expected inflation, unemployment temporarily decreases. However, after people revise their price expectations upward and ask for higher wages, the Phillips curve shifts upward (to the right).

In what term does the Phillips curve parallel with the Aggregate-demand curve?

Short-run

Referring to question 8 above, if the Fed accommodates the adverse supply shock, what have they revealed about the weights they attach to the goals of low inflation and low unemployment?

The Fed is more concerned with low unemployment.

What will happen to the unemployment rate, inflation rate, and real GDP if the central bank increases the money supply?

The Inflation rate will increase while unemployment and real GDP stay unchanged.

What is the natural rate hypothesis?

The proposition that when the inflation rate changes, the unemployment rate changes temporarily and eventually returns to the natural unemployment rate.

What is the misery index?

The sum of inflation and unemployment

What is the natural-rate hypothesis?

The theory that unemployment returns to its natural rate, regardless of inflation

What is the sacrifice ratio?

the number of percentage points of annual output lost in the process of reducing inflation by 1 percentage point