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

Question 1

An increase in aggregate demand temporarily reduces unemployment, but after people raise their expectations of inflation, unemployment returns to the natural rate.

Answer 1

True

Question 2

When actual inflation exceeds expected inflation, unemployment exceeds the natural rate.

Answer 2

False

Question 3

An increase in expected inflation

A)shifts the short run Phillips curve downward and the unemployment inflation trade-off is less favourable.
B)shifts the short run Phillips curve upward and the unemployment inflation trade-off is more favourable.
C)shifts the short run Phillips curve downward and the unemployment inflation trade-off is more favourable.
D)shifts the short run Phillips curve upward and the unemployment inflation trade-off is less favourable.

Answer 3

shifts the short run Phillips curve upward and the unemployment inflation trade-off is less favourable.

Question 4

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

Question 5

If people have rational expectations, an announced monetary contraction by the central bank that is credible could reduce inflation with little or no increase in unemployment.

Question 6

The natural rate hypothesis suggests that, in the long run, unemployment returns to its natural rate, regardless of inflation.

Question 7

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.

A)Arthur Brown
B)Jan Tinbergen
C)Karl Marx
D)David Hume

Question 8

One explanation that economists offer to explain why a decline in the unemployment rate can raise the rate of inflation is that

A)firms will be put in a position of competing more intensely for scarce resources.
B)people will pay higher prices because competition among suppliers intensifies.
C)workers will focus more directly on protecting their jobs.
D)firms will refuse to shift higher labour costs along to consumers for fear of losing their markets.

Question 9

The original Phillips curve illustrates the

A)trade-off between inflation and unemployment.
B)trade-off between output and unemployment.
C)positive relationship between output and unemployment.
D)positive relationship between inflation and unemployment.

Question 10

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

A)left and a move up the short run Phillips curve.
B)left and a move down the short run Phillips curve.
C)right and a move up the short run Phillips curve.
D)right and a move down the short run Phillips curve.

Question 11

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

A)pressure will build in the economy to continuously reduce the rate of inflation.
B)the long run Phillips curve becomes horizontal, freezing the rates of inflation and unemployment.
C)the inflation rate will increase but the unemployment rate will stay at 7 per cent.
D)in the long run the rate of unemployment remains unchanged, but inflation will probably accelerate.

Question 12

A sudden monetary contraction moves the economy up a short run Phillips curve, reducing unemployment and increasing inflation.

Question 13

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

Question 14

The Phillips curve is an extension of the model of aggregate supply and aggregate demand because, in the short run, an increase in aggregate demand increases prices and

A)decreases growth.
B)decreases unemployment.
C)increases unemployment.
D)decreases inflation.

Question 15

An increase in price expectations shifts the Phillips curve upward and makes the inflation unemployment trade-off less favourable.

Question 16

According to the Phillips curve, in the short run, if policy makers choose an expansionary policy to lower the rate of unemployment,

A)the economy will experience an increase in inflation.
B)the economy will experience a decrease in inflation.
C)inflation will be unaffected if price expectations are unchanging.
D)None of these answers.

Question 17

When unemployment is below the natural rate the labour market is unusually tight, putting pressure on wages and prices to rise.

Question 18

Along a short run Phillips curve, a higher rate of

A)growth in output is associated with a higher unemployment rate.
B)growth in output is associated with a lower unemployment rate.
C)inflation is associated with a higher unemployment rate.
D)inflation is associated with a lower unemployment rate.

Question 19

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

A)has a slope that is determined by how fast people adjust their price expectations.
B)is negatively sloped.
C)is vertical.
D)is positively sloped.

Question 20

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

Question 21

In moving along a short run Phillips curve we are holding which of the following constant?

A)The level of GDP.
B)The actual inflation rate.
C)The expected inflation rate.
D)Employment.

Question 22

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

A)(the natural rate) + a(the expected inflation rate).
B)(the natural rate) - a(the expected inflation rate).
C)(the expected inflation rate) + (the actual inflation rate).
D)(the natural rate) - a(the actual inflation rate - the expected inflation rate).

Question 23

Refer to Exhibit 6 above.Suppose the economy is operating at point D.As people revise their price expectations,

A)the short run Phillips curve will shift in the direction of the short run Phillips curve associated with an expectation of 3 per cent inflation.
B)the short run Phillips curve will shift in the direction of the short run Phillips curve associated with an expectation of 9 per cent inflation.
C)the short run Phillips curve will shift in the direction of the short run Phillips curve associated with an expectation of 6 per cent inflation.
D)the long run Phillips curve will shift to the left.

Question 24

If people expect less inflation in the future, then the

A)long run Phillips curve will become steeper.
B)long run Phillips curve will become flatter.
C)short run Phillips curve will become steeper.
D)short run Phillips curve will shift down and to the left.

Question 25

The natural rate of unemployment is

A)the socially desired rate of unemployment.
B)the unemployment rate that is observed in the long run regardless of the monetary policy pursued by the central bank.
C)the unemployment rate that is observed in the long run regardless of all economic policies pursued by the government or central bank.
D)always below 5 per cent.

Question 26

If a central bank decreases the money supply, then

A)prices, output, and unemployment rise.
B)prices and output rise and unemployment falls.
C)prices rise and output and unemployment fall.
D)prices and output fall and unemployment rises.

Question 27

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

A)A.
B)C.
C)D.
D)F.
E)H.

Question 28

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

A)A.
B)B.
C)E.
D)H.
E)I.

Question 29

Which of the following would shift the long run Phillips curve to the right?

A)An increase in the minimum wage.
B)An increase in expected inflation.
C)An increase in the price of foreign oil.
D)An increase in aggregate demand.

Question 30

When actual inflation exceeds expected inflation,

A)unemployment is equal to the natural rate of unemployment.
B)people will reduce their expectations of inflation in the future.
C)unemployment is greater than the natural rate of unemployment.
D)unemployment is less than the natural rate of unemployment.

Question 31

The long run Phillips curve is vertical at

A)zero unemployment.
B)zero frictional unemployment.
C)the natural rate of unemployment.
D)the natural rate of inflation.

Question 32

Which of the following will reduce the price level and increase real output in the long run?

A)An increase in the money supply.
B)An increase in wage rates.
C)A decrease in the money supply.
D)Technical progress.

Question 33

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

A)A.
B)C.
C)E.
D)F.
E)H.

Question 34

An increase in expected inflation will shift

A)both the short run and the long run Phillips curves to the right.
B)only the short run Phillips curve to the right.
C)only the long run Phillips curve to the right.
D)the short run Phillips curve to the right and increase the slope of the long-run Phillips curve.

Question 35

If policymakers expand aggregate demand, then in the long run

A)prices will be higher and unemployment will be lower.
B)prices will be higher and unemployment will be unchanged.
C)prices and unemployment will be unchanged.
D)None of the above is correct.

Question 36

A decrease the price of foreign oil

A)shifts the short run Phillips curve downward, and makes the unemployment inflation trade-off less favourable.
B)shifts the short run Phillips curve upward, and makes the unemployment inflation trade-off less favourable.
C)shifts the short run Phillips curve upward, and makes the unemployment inflation trade-off more favourable.
D)shifts the short run Phillips curve downward, and makes the unemployment inflation trade-off more favourable.

Question 37

The natural rate hypothesis argues that

A)in the long run, the unemployment rate returns to the natural rate, regardless of inflation.
B)unemployment is always below the natural rate.
C)unemployment is always above the natural rate.
D)unemployment is always equal to the natural rate.

Question 38

Refer to Exhibit 6 above.Suppose the economy is in long run equilibrium at point E.A sudden increase in government spending should move the economy in the direction of point

A)A.
B)B.
C)D.
D)E.
E)G.

Question 39

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

A)rise and unemployment falls.
B)fall and unemployment rises.
C)and unemployment rise.
D)and unemployment fall.

Question 40

The pattern of employment and inflation observed during the 1970s appeared to confirm the view of Phelps and Friedman that

A)the Phillips curve was upward sloping, not downward sloping as first thought.
B)there was no trade-off between inflation and unemployment in the long run.
C)the expected trade-offs did not occur, meaning that policy to lower unemployment rates would not cause inflation.
D)the aggregate supply curve actually sloped downward because price levels fell when real GDP rose.

Question 41

Why does a downward sloping Phillips curve imply a positive sacrifice ratio?

Question 42

Which of the following would tend to shorten recessions associated with the use of anti-inflation policies?

A)People adjust their expectations of inflation slowly.
B)People believe policy announcements made by economic policy makers.
C)The short run Phillips curve does not shift immediately.
D)All of the above are correct.

Question 43

Suppose that the economy is at an inflation rate such that unemployment is above the natural rate.How does the economy return to the natural rate of unemployment if this lower inflation rate persists? Use sticky wage theory to explain your answer.

Question 44

Suppose that an economy is currently experiencing 10 per cent unemployment and 15 per cent inflation.If, in the process of bringing inflation down by 2 per cent real GDP falls by 4 per cent, the sacrifice ratio is

A)5 per cent.
B)2 per cent.
C)12 per cent.
D)None of the above is correct.

Question 45

An independent central bank is an advantage for monetary policy because

A)central banks can employ the most able staff if they have the independence to pay high salaries.
B)central banks have direct and frequent contact with commercial banks.
C)central banks do not have the same incentive as politicians to break their promises to keep inflation down.
D)central banks have greater expertise in monetary policy than government finance departments.

Question 46

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.

Question 47

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

A)A.
B)B.
C)F.
D)H.
E)I.

Question 48

A policy of inflation targeting generally involves targeting the future rate of inflation because

A)monetary policy changes made today will take time to have an effect on the economy.
B)monetary policy involves changing interest rates and interest is paid annually.
C)economists are only ever interested in the future.
D)workers and their unions consider future inflation in their negotiations with employers.

Question 49

Some countries have had relatively high inflation and relatively high unemployment for long periods of time.Is this consistent with the Phillips curve? Defend your answer.

Question 50

Explain the connection between the vertical long run aggregate supply curve and the vertical long run Phillips curve.

Question 51

According to the theory of rational expectations,

A)workers' experience tells them that government action to lower unemployment will not affect inflation.
B)consumers and investors generally behave so that rationally formed government attempts to stimulate aggregate demand have their desired effects.
C)policy goals can be achieved more easily in the short run than in the long run.
D)workers' wage demands include anticipated inflation.

Question 52

If the sacrifice ratio is five, a reduction in inflation from 7 per cent to 3 per cent would require

A)a reduction in output of 5 per cent.
B)a reduction in output of 15 per cent.
C)a reduction in output of 20 per cent.
D)a reduction in output of 35 per cent.

Question 53

The Phillips curve and the short run aggregate supply curve are closely related, yet one slopes downward and the other slopes upward.Discuss.

Question 54

According to the theory of rational expectations,

A)the Phillips curve is upward sloping in the short run and downward sloping in the long run.
B)both in the short and long run, the Phillips curve is horizontal.
C)the sacrifice ratio could be zero because economic agents will very quickly adjust their inflation expectations if they believe policy makers will succeed in reducing inflation.
D)the sacrifice ratio is very high because rational workers will work less if their wages do not rise as quickly as they expect.

Question 55

If a country's policy makers were to continuously use expansionary monetary policy in an attempt to hold unemployment below the natural rate, the long run result would be

A)an increase in the level of output.
B)a decrease in the unemployment rate.
C)an increase in the rate of inflation.
D)all of these answers.

Question 56

Suppose that a central bank unexpectedly pursues contractionary monetary policy.What will happen to unemployment in the short run? What will happen to unemployment in the long run? Justify your answer using the Phillips curves.

Question 57

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

Question 58

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?

Question 59

If people have rational expectations, a monetary policy contraction that is announced and is credible could

A)reduce inflation with little or no increase in unemployment.
B)increase inflation but it would decrease unemployment by an unusually large amount.
C)increase inflation with little or no decrease in unemployment.
D)reduce inflation but it would increase unemployment by an unusually large amount.

Question 60

What did Milton Friedman and Edmund Phelps predict would happen if policymakers tried to move the economy upward along the Phillips curve? Did the behaviour of the economy in the late 1960s and the 1970s prove them wrong?