Phillips Curve 1.
1. In a certain economy the expectations-augmented Philips curve is:
Π = Πe - 2(u-u*) u* = 0,06 (natural rate of unemployment)
A. Graph the Phillips curve of this economy for an expected inflation rate of 0,1. If the central bank chooses to keep the actual inflation at 0,1%, what will be the unemployment rate. If the central bank unexpectedly increases inflation, what will happen to unemployment and why (explain using the AS/AD model)
B. A demand shock raises expected inflation to 0,12. Graph the new Phillips curve. What happens to unemployment rate if the central bank holds inflation at 0,1% after the demand shock?
c. Suppose a supply shock raises the expected inflation to 0,12 and natural rate of unemployment to 0,08. Repeat part B.
2. An economy is described by the following
AD Y = 4000 + 2(M/P)
SAS Y = Ypotential + 100 (P - Pe)
Okun’s Law (Y - Ypot)/Ypot = -2(u-unat)
In this economy Ypot = 6000 and unat=0,05
A. Suppose that the nominal money supply has long been constant at M = 4000 and is expected by the public to remain constant forever. What are the equilibrium values of the price level P, the expected price level, expected inflation, output and unemployment?
B. A totally unexpected increase in M occurs from 4000 to 4488. What are the short-run values of price level, expected price level, output and unemployment rate? What are the values of cyclical unemployment and unanticipated inflation.
C. What is the slope of the expectations-augmented Phillips curve?
3. Suppose that the government institutes a new program to help unemployed workers learn new skills and find jobs.
A. If this program reduces structural unemployment, what is the effect on AS/AD model and expectations-augmented Phillips curve?
B. The program is expensive, and critics argue that a cheaper way to cut unemployment would be by monetary expansion. Comment.
4. Two economies differ only in one respect: in economy A money growth and inflation have been low and stable for many years, while in economy B money growth and inflation have fluctuated erratically between very low and very high levels. When B’s produers observe changes in prices of the goods that hey produce, from past experience they usually attribuite these changes to fluctuations in the overall price level rather than to changes in the relative prices of their goods. Using misperceptions theory: will the slope of SAS for economy B be flatter or steeper than the slope of SAS for economy A? What about the slope of the Phillips curve?
5. Disinflation is usually costly. If the central bank could choose a model, within which the economy operates (Classical/misperceptions/Keynesian approach to business cycle), which should it choose to decrease disinflation costs?
6. Suppose the Phillips curve is given by:
Π = Πe + 0,1 -2u, where u is unemployment
Suppose also that Πe = Θ Πt-1 and Θ = 1
Initial inflation is equal to zero.
Calculate the natural rate of unemployment.
Suppose the government is determined to keep u at 3%. What will the inflation rate be in years t+1, t+2?
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