Scribd
Upload
130 views

Lesson 26 Activity

The document discusses the Phillips curve and its implications. It provides information on: - The short-run Phillips curve shows an inverse relationship between inflation and unemployment. According to the curve, lower unemployment can be achieved with higher inflation. - In the long-run, the Phillips curve is vertical at the natural rate of unemployment. Both inflation and unemployment cannot be sustained below these rates. - The relationship depicted by the Phillips curve broke down in the 1970s with stagflation, high inflation and unemployment. This challenged the stability of the short-run trade-off. - Monetary and fiscal policy can be used to target unemployment or inflation, with trade-offs, according to positions of the

Uploaded by

Randy Wang
Copyright
© © All Rights Reserved
Available Formats
Download as DOC, PDF, TXT or read online on Scribd
130 views

Lesson 26 Activity

The document discusses the Phillips curve and its implications. It provides information on: - The short-run Phillips curve shows an inverse relationship between inflation and unemployment. According to the curve, lower unemployment can be achieved with higher inflation. - In the long-run, the Phillips curve is vertical at the natural rate of unemployment. Both inflation and unemployment cannot be sustained below these rates. - The relationship depicted by the Phillips curve broke down in the 1970s with stagflation, high inflation and unemployment. This challenged the stability of the short-run trade-off. - Monetary and fiscal policy can be used to target unemployment or inflation, with trade-offs, according to positions of the

Uploaded by

Randy Wang
Copyright
© © All Rights Reserved
Available Formats
Download as DOC, PDF, TXT or read online on Scribd
You are on page 1/ 5

Randy Wang

Inflation and the Phillips Curve

Inflation
Read the handouts on cost-push and demand-pull theories of inflation. Then answer the following questions:
1. In your own words explain the demand-pull theory of inflation. The demand pull theory of inflation is a scenario
where price levels experience sharp increase because the aggregate demand and aggregate supply are not
balanced.

2. What shape does the long-run aggregate supply curve take according to Classical economists? The shape of the
long-run aggregate supply curve is a vertical line, according to classical economists.

3. What are the implications for government interventions in the economy according to Classical economics? The
economic impacts of monetary policy were not considered and they did not consider short-run effects as important.

4. What are the major differences between a Keynesian economists view of the labor market and that of a Classical
economist? The Classical economist believed that wages and prices stabilize over time with fluctuation, and the
economy is at full employment, meaning that every single person who wants a job has one. On the other hand, with
the Keynesian economist, they would believe that the economy is not always at full employment, and that the
economy could be below the potential.

5. In your own words explain the cost-push theory of inflation. This theory says that when the costs of raw materials
and wages increases dramatically, the general price level will increase, symbolizing inflation.

6. What term do we use to describe the economic situation when natural resources are exhausted? Not sure.

Short-Run Phillips Curve


A.W. Phillips studied the historical relationship between the rate of change in wages and the unemployment rate in the
United Kingdom. In 1958 he published his findings, showing an inverse relationship between these variables. In following
studies, other economists found that the inverse relationship held when a change in the level of prices (inflation) was
used in place of the rate of change in wages. In other words, when inflation increased, the unemployment rate
decreased; and when inflation decreased, the unemployment rate increased. A graphic representation of this tradeoff
became known as the Phillips curve.
In Figure 46.1, an example of the Phillips curve illustrates the trade-off between
inflation and unemployment, or all of the different possible combinations of inflation
and unemployment that exist along the curve.
The economy of the 1960s appeared to support Phillips hypothesis. The economy
was sluggish, inflation was low and the unemployment rate was high. Since the
unemployment rate was higher than the natural rate of unemployment, the economy
was not operating at its potential GDP. The Phillips curve suggested to some
economists that if policy makers wished to lower unemployment, the trade-off would
be higher inflation.
1. Suppose government policy makers want to increase GDP because the economy is not operating at its potential.
They can increase aggregate demand by increasing government spending, lowering taxes or a combination of both.
Using an AD and SRAS model, draw a new AD curve that will represent the change caused by government policy
designed to increase real GDP.
(A) What happens to the price level in the short run? ___increases__
(B) What happens to real GDP in the short run? _____increases_____
(C) What happens to the rate of unemployment in the short run?
__decreases_____
(D) The Federal Reserve can use monetary policy to try to stimulate the economy.
It can encourage bank lending by ____purchasing___ bonds on the open market, __decreasing______ the
discount rate and/or _____decreasing______ the reserve requirements.
A Phillips curve would tell the same story. Inflation is low at high levels of
unemployment, but inflation begins to increase as the unemployment rate decreases.
The Phillips curve is useful for analyzing short-run movements of unemployment and
inflation. See Figure 46.3.
In the late 1960s, some economists such as Milton Friedman and Edmund Phelps
published papers that concluded there were two Phillips curves: one for the short run
and one for the long run. The controversy continued as the economy of the 1970s
experienced high inflation and high unemployment at the same time. The relationship
appeared to be less stable than previously thought; the short-run Phillips curve had
shifted to the right.

2. Aggregate supply shocks resulting from the oil embargo imposed by Middle
Eastern countries (OPEC) and worldwide crop failures helped to bring about
higher inflation and higher unemployment rates. The economy, with rising
prices and decreased output, was in a state of stagflation. Using an AD and
SRAS model, draw a new SRAS curve that will represent the change caused
by the OPEC oil embargo.
(A) In the short run, based on the new SRAS:
(i)

What happens to the price level? _____increases_____

(ii)

What happens to real GDP? ____decreases________

(iii)

What happens to the rate of unemployment? _______increases_________

(B) As the economy moves to the long run:


(i)

What happens to the wage rate? __It will decrease because the unemployment rate has increased.

(ii)

What happens to the price level? ___The SRAS shifts back to the old SRAS so the wage rate will go
down and price level will go to normal.

(iii)

What happens to real GDP? __The output will go back to normal.

(iv)

What happens to the rate of unemployment? It will go down temporarily, and then go back to original
level.

3. Use the AD and SRAS model in Figure 46.6 to show the appropriate policy
response to the oil-price increases in the following instances. Be sure to show on
the graph the effects of the oil-price increase.
(A) If unemployment were the main concern of policy makers. The
unemployment will increase AD to AD1 with fiscal and monetary policy.
(B) If inflation were the main concern of policy makers. When inflation is a
concern, policy makers will use the same policies and move the economy
back to the same price level and output.
(C) If inflation and unemployment were of equal concern. If they are equally concerning, the expansionary policies
will be used to move aggregate demand to AD1.

1.

The government debt is monetized when the:


A. Treasury mints new currency in order to buy Treasury
bills back from foreign governments.
B. Fed conducts open-market purchases to buy Treasury
bills from the public.
C. Fed transfers part of its financial reserves to the
Treasury, who in turn buys Treasury bills back.

D. Fed sells Treasury bills in the bond market.


E. Treasury mints new currency in order to buy Treasury
bills back from the Fed.
2.

The inflation tax refers to:


A. moving into higher income tax brackets.
B. the reduction in the real value of money when inflation falls.

3.

C. the reduction in the real value of money when inflation rises.


D. the tax placed on inflation by the government.
E. the increase in income tax revenues from a growing economy.
When the output gap is _________, reflecting an
inflationary gap, the unemployment rate is _________ the
natural rate of unemployment.
A.
positive; above
B.
negative; below
C.
positive; below
D.
negative; above
E.
negative; equal to

4.

If the natural rate of unemployment is 5%, and the actual


rate of unemployment is 4%:
A.
disinflation is likely to occur.
B.
there will be no effect on prices.
C.
inflation will increase.
D.
the short-run Phillips curve will shift down.
E.
deflation is likely to occur.

5.

Which of the following is likely to be TRUE if actual


output is equal to potential output?
A. The actual unemployment rate is equal to the natural rate
of unemployment.
B. The actual unemployment rate is above the natural rate
of unemployment.
C. The natural rate of unemployment is zero.
D. The natural rate of unemployment will be above the
actual unemployment rate.
E. the actual unemployment rate is zero.

6.

The short-run Phillips curve shows:


A. a direct relationship between unemployment and inflation.
B. an inverse relationship between unemployment and
inflation.
C. consequences of the misperceptions theory.
D. the optimum level of employment.
E. an inverse relationship between unemployment and the
real interest rate.

7.

If the Fed reduces the inflation rate from 5% to 3%, it is:


A.
following a policy rule.
B.
engaging in disinflation.
C.
increasing employment.
D.
raising economic growth.
E.
decreasing the unemployment rate.

LESSON 26: PHILLIPS CURVE


TASK 4: Phillips Curve Unit
The table below shows data for the average annual rates of unemployment and inflation for the economy
of Britannia from 1998 to 2007.

The scatter plot below is depicting the same data:

a. Are the data consistent with a short-run Phillips curve? The data is consistent because there is a definite
trade-off between inflation and unemployment rate.
b. If the government pursues expansionary monetary policies in the future to keep the unemployment rate
below the natural rate of unemployment, how effective will such a policy be? It will not be effective
because individuals will have increased expectations regarding inflation and the trade-offs will be nullified.

You might also like