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Chapter 18: Q4. (page 389)

Suppose that for years East Confetti’s short-run Phillips Curve was such that each 1 percentage point increase in its unemployment rate was associated with a 2 percentage point decline in its inflation rate. Then, during several recent years, the short-run pattern changed such that its inflation rate rose by 3 percentage points for every 1 percentage point drop in its unemployment rate. Graphically, did East Confetti’s Phillips Curve shift upward or did it shift downward? Explain.

Short Answer

Expert verified

The following graph shows the upward shift in East Confetti’s Philips Curve.

The economy moved downwards along the Philips curve in the short run, causing a fall in the inflation rate and a rise in the unemployment rate. However, the Philips curve shifted upward in the long run, causing a rise in the inflation rate only while unemployment remained fixed at the natural rate.

Step by step solution

01

The illustration of Philips curve 

The Philips curve shows a tradeoff between unemployment and inflation rates.

The following figure depicts the relevant Philips curve.

02

The explanation for the graph 

In the short run, the economy moves from E1 to E2. Correspondingly, the unemployment rate increases by 1 percent, and the inflation rate declines by 2 percent.

In the long run, the economy moves from E1 to E3; correspondingly, the unemployment rate declines by 1 percent, and the inflation rate rises by 3 percent.

Hence, it can be inferred from the above figure that East Confetti’s Philips Curve has shifted upwards, due to which there has been a 3 percent rise in inflation rate and a 1 percent fall in the unemployment rate.

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Most popular questions from this chapter

What is the Laffer Curve, and how does it relate to supply-side economics? Why is determining the economy’s location on the curve so important in assessing tax policy?

Between 1990 and 2009, the U.S. price level rose by about 64 percent while real output increased by about 62 percent. Use the aggregate demand–aggregate supply model to illustrate these outcomes graphically.

Suppose the full-employment level of real output (Q) for a hypothetical economy is $250 and the price level (P) initially is 100. Use the short-run aggregate supply schedules below to answer the questions that follow:

AS(P100)
AS(P125)
AS(P75)
PQPQPQ
125280125250125310
100250100220100280
752207519075250

What is the level of real output in the short run if the price level unexpectedly rises from 100 to 125 because of an increase in aggregate demand? What happens if the price level unexpectedly falls from 100 to 75 because of a decrease in aggregate demand? Explain each situation, using numbers from the table.

b. What is the level of real output in the long run when the price level rises from 100 to 125? When it falls from 100 to 75? Explain each situation.

c. Illustrate the circumstances described in parts a and b on graph paper, and derive the long-run aggregate supply curve.

Distinguish between the short run and the long run as they relate to macroeconomics. Why is the distinction important?

What is the Laffer Curve, and how does it relate to supply-side economics? Why is determining the economy’s location on the curve so important in assessing tax policy?
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