Exam 17: The Short Run Trade-Off Between Inflation and Unemployment

If policymakers expand aggregate demand, then in the long run

For centuries economists have puzzled over the relationship between a nation's money supply and its economic prosperity.In 1752, __________ suggested that if the money supply is increased when an economy is below full employment, spending will increase, which in turn creates economic expansion.

The long run Phillips curve is vertical at

-Refer to Exhibit 6 above.Suppose the economy is operating in long run equilibrium at point E.An unexpected monetary contraction will move the economy in the direction of point

-Refer to Exhibit 6 above.If people in the economy expect inflation to be 6 per cent but inflation turns out to be 3 per cent, the economy is operating at point

An independent central bank is an advantage for monetary policy because

-Refer to the Figure above.Suppose that the government in the economy of this diagram regards 9 per cent unemployment as unacceptable.If the government insists on trying to reduce the unemployment rate from 9 per cent to 7 per cent, regardless of the consequences, then

In the long run what primarily determines the natural rate of unemployment? In the long run what primarily determines the inflation rate? How does this relate to the classical dichotomy?

If a central bank decreases the money supply, then

-Refer to the Figure above.Suppose the government decreases tax rates dramatically in order to decrease the level of employment.We would expect to see aggregate demand shift to the

Some economists argue suddenly reducing money supply growth is a costly way to reduce inflation and that it may not work.For example, if a government cuts money growth but makes no real fiscal reforms, people will expect the government will eventually need to expand the money supply to pay for its expenditures.Thus, the promise to fight inflation will not be credible.Explain why credibility is important to a reduction in the inflation rate.

An increase in expected inflation

The Phillips curve illustrates the positive relationship between inflation and unemployment.

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

According to Friedman and Phelps, the unemployment rate is equal to

A decrease the price of foreign oil

If the central bank increases the money supply, then in the short run prices

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

Explain how the effects of a shift in the aggregate demand curve are consistent with the Phillips curve.

If, in the long run, people adjust their price expectations so that all prices and incomes move proportionately to an increase in the price level, then the long run Phillips curve