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EC1002 - Sheet 17

The document consists of an economics sheet with true/false statements regarding inflation, unemployment, and the Phillips curve, followed by long-answer questions analyzing the effects of supply shocks and monetary policy credibility. It discusses the implications of various economic scenarios, including the impact of inflation on national debt and the role of central banks in managing expectations. Additionally, it explores the Phillips curve's representation of the relationship between inflation and unemployment, and the effects of shocks on output and price levels.

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Silvina wafiq
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36 views2 pages

EC1002 - Sheet 17

The document consists of an economics sheet with true/false statements regarding inflation, unemployment, and the Phillips curve, followed by long-answer questions analyzing the effects of supply shocks and monetary policy credibility. It discusses the implications of various economic scenarios, including the impact of inflation on national debt and the role of central banks in managing expectations. Additionally, it explores the Phillips curve's representation of the relationship between inflation and unemployment, and the effects of shocks on output and price levels.

Uploaded by

Silvina wafiq
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as DOCX, PDF, TXT or read online on Scribd
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EC1002 Introduction to Economics

Sheet 17
(Block 17)
Part A: State if the following statements are true, false, or uncertain and justify.
1. If inflation is below the target, the central bank lowers the nominal interest rate to a level
which decreases the real interest rate.
2. A decrease in the natural rate of unemployment would cause the long-run Phillips curve
(LRPC) to shift to the left.
3. A new central bank governor is appointed with the task of reducing inflation. However,
the new governor lacks credibility, and no-one expects inflation to fall. Supposing the
central bank really does tighten monetary policy and succeed in reducing inflation The
short-run Phillips curve will shift downwards.
4. Higher expected inflation shifts the long-run Phillips curve leftwards.
5. A positive demand shock leads to no change in the position of the short-run Phillips
curve.
6. Inflation increases the ratio of national debt to national income.
Part B: Long Questions.
Question 1:
Disruption to the supply of natural gas to Atlantis has caused a surge in energy prices. While
Atlantis has had a period of inflation around 2% for several years, the current rate of inflation is
6%.
(a) What type of shock has affected Atlantis and how has it fueled inflation?
(b) Explain what is meant by the natural rate of unemployment and explain why the long-run
Phillips curve is vertical at that rate. Why is inflation constant in the long-run equilibrium?
(c) Analyse the effect of the shock on Atlantis using short- and long-run Phillips curves. Explain
how the Central Bank’s willingness to accommodate the shock affects inflation and
unemployment in Atlantis.
(d) Explain why the credibility of monetary policy is important.
Question 2:

Suppose aggregate supply in the United Kingdom is Y =Y ¿ +50 ( π−π e ), where Y denotes output,
¿
Y denotes potential output, π denotes the inflation rate and π e denotes the expected rate of
inflation. Also Y −Y ¿=−10 ( u−u¿ ), where u denotes the unemployment rate and u¿ denotes the
equilibrium (or natural) rate of unemployment.

Al. Sylvana Wafik


(a) Find the expectations augmented short-run Phillips curve for this economy and sketch it
in a diagram, explaining its shape. Add the long-run Phillips curve to your diagram and
explain its shape.

(b) The Bank of England has an inflation target of 2 per cent. However, inflation in the UK
has been below target at 1 per cent due to the economic effects of the coronavirus
pandemic. Analyse the effects on unemployment, output and inflation in the short-run and
long-run if:
(i) the inflation target is credible
(ii) expectations are adaptive, so π et =π t−1.

(c) Suppose the inflation rate is on target at 2 per cent. However, it is a widely held belief
that the United Kingdom’s departure from the European Union (known as ‘Brexit’) will
increase the inflation rate through higher import prices. Could such a belief be self-
fulfilling?

(d) “The specific inflation target does not matter, provided it is credible.” Do you agree with
this statement? Explain why, or why not.

Question 3:
a) What does the Phillips curve represent? Draw a diagram with a short- run Phillips curve
and a long-run Phillips curve and explain why they have the shapes they do.
b) Draw diagrams (explaining your answers in words at the same time) to depict what will
happen to output, unemployment and the inflation rate when there is: i. a fall in the price of
oil that is fully accommodated by monetary policy ii. a new, very tough and inflation-
hating central bank governor appointed in a period of high inflation.
c) Certain types of inflation can have very serious implications. Discuss the implications
of: i. negative inflation ii. hyperinflations.
Question 4:
Use the LRAS and the long-run Phillips curve, together with the short-run curves, to depict what
will happen to output, unemployment and the price level when there is:

a. a negative shock to aggregate demand in the context of a credible, constant inflation


target.
b. an expectation that the inflation rate will rise and that the central bank will not be able to
contain this.
c. the productivity of the labor force increases permanently (for example due to changes in
the county's education and training systems).
d. a temporary adverse supply shock that is not fully accommodated.

Al. Sylvana Wafik

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