Subjective Short Answer
1. As the aggregate demand curve shifts to the right, what happens to the price level and output? What do these changes
imply happens to the inflation rate and the unemployment rate?
2. According to the Phillips curve, which fiscal policies can be used to reduce unemployment in the short run?
3. If asset prices fall and inflation expectations remain unchanged, what happens to inflation and unemployment? Defend
your answer.
4. Suppose that businesses become less optimistic about the future. Assuming no change in inflation expectations, how
would the effects of this shock be shown on the Phillips curve diagram and what would happen to inflation and
unemployment?
5. Government expenditures increase. What happens to the price level and output? Explain how the change in the price
level and output effect the inflation rate and the unemployment rate.
6. If consumer confidence rises and inflation expectations remain unchanged, what happens to inflation and
unemployment? Defend your answer.
7. U.S. net exports fall due to recessions in foreign countries.
A. According to the aggregate demand and supply model, what happens to the price level and output in the short run?
B. According to the short-run Phillips curve what happens to inflation and unemployment in the short run?
C. If the Fed wanted to reverse the effects of this shock on output, what should it do?
8. According to the long-run Phillips curve, if the Fed increases the growth rate of the money supply, what happens to the
inflation rate and the unemployment rate in the long run?
9. What is meant by the natural rate of unemployment?
10. List one specific policy that would shift the long-run Phillips curve to the right.
11. Suppose, as in the 1970’s in the U.S., that demographic groups which typically have higher unemployment rates
become a larger percentage of the labor force. Would this have any effect on the long-run Phillips curve?
12. For a given short-run Phillips curve, if expected inflation is 10% but actual inflation is 8%, is the unemployment rate
above or below its natural rate?
13. If expected inflation rises but actual inflation remains the same, what happens to the unemployment rate? Defend your
answer.
14. If expected inflation decreases does the short-run Phillips curve shift? If so, what direction does it shift? Does the
long-run Phillips curve shift? If so, what direction does it shift?
15. If the Fed raised the money supply growth by more than expected then the unemployment rate would _____ in the
short run. Explain the process by which the economy moves to the long run if the Fed maintains the higher money supply
growth rate.
16. What does the natural-rate hypothesis claim?
17. An increase in the natural rate of unemployment shifts the short-run Phillips curve to the _____. If the central bank
sees the increase in the unemployment rate, but thinks the natural rate has remained the same and so wants to reduce
unemployment, it would ________ the money supply growth rate. If it maintains this money supply growth rate,
eventually the short run Phillips curve will shift _____ and unemployment will be _____.
18. The Fed increases the money supply growth rate. Assuming inflation expectations remain constant, use a Phillips
curve diagram to show the short-run effects of the Fed’s policy.
19. What does an unexpected decrease in the growth rate of the money supply do to inflation and unemployment in the
short-run? What does it do to inflation and unemployment in the long run?
20. For a given short-run Phillips curve, if expected inflation is 8% but actual inflation is 10%, is the unemployment rate
above or below its natural rate?
21. If expected inflation falls but actual inflation remains the same, what happens to the unemployment rate? Defend your
answer.
22. Use the sticky-wage theory of aggregate demand to explain the short-run Phillips curve.
23. Write the equation representing the short-run Phillips curve.
24. List three things that shift the short-run Phillips curve to the right.
25. Friedman and Phelps argued that it was dangerous to think of the short-run Phillips curve as a menu of options for
policymakers to choose from. Explain the logic of their argument.
26. How is a decrease in the natural rate of unemployment shown in the Phillips curve diagram? Does this decrease
change the inflation rate?
27. A central bank raises the money supply growth rate and keeps it at that higher rate. Explain the process by which the
economy moves to long-run equilibrium.
28. A central bank raises the money supply growth rate and keeps it higher. As the economy moves from the short-run
equilibrium created by the increase in the money supply growth back to long-run equilibrium what happens to the
unemployment rate?
29. What evidence does the Volcker disinflation provide concerning the importance of inflation expectations to the costs
of disinflation?
30. How are the effects of a favorable supply shock shown in the Phillips curve diagram? If the Fed wants to return
unemployment to its natural rate after the shock, what should it do?
31. If there is a large and sudden but temporary increase in the price of oil, which way does the short-run Phillips curve
shift? If the central bank does not respond what happens to inflation and the unemployment rate in the long run?
32. If there is a favorable supply shock which direction does the short-run Phillips curve shift? What initially happens to
unemployment and inflation as a result of this shock?
33. What is meant by accommodation?
34. If the Fed responded to an adverse supply shock by increasing the growth rate of the money supply and maintained the
higher growth rate, what would eventually happen to the short-run Phillips curve? Why?
35. If there were a favorable supply shock and the central bank wanted to offset the change in the unemployment rate,
what would it do?
36. How does a central bank’s accommodation of an adverse supply shock change the long-run results of the shock?
37. What would a central bank need to do to reverse the effects of a favorable supply shock on inflation? What would its
reaction do to the unemployment rate in the short run?
38. Suppose that a central bank reduces the money supply growth rate to disinflate. What does disinflation mean? If
people do not alter their inflation expectations, what happens to output and unemployment?
39. Suppose the price level is 110.00 at the end of 2020, 121.00 at the end of 2021, and 128.26 at the end of 2022. Can we
accurately describe the period 2021-2022 as a period of disinflation?
40. Suppose the price level is 115.00 at the end of 2020, 112.02 at the end of 2021, and 109.08 at the end of 2022. Can we
accurately describe the period 2021-2022 as a period of disinflation?
41. If because they expect the central bank to disinflate, people reduce their inflation expectations, then is the sacrifice
ratio larger or smaller the otherwise? Defend your answer by referring to the Phillips curve.
42. A central bank disinflates. Output falls by 3% for one year, 2% the second year, and 1% the third year. If inflation fell
by 2 percentage points, what was the sacrifice ratio?
43. A central bank pledges to reduce the inflation rate from 20% to 5%. People reduce their inflation expectations to 10%,
but the central bank only reduces inflation to 15%. What happens to the unemployment rate?
44. According to the Phillips curve diagram, if a central bank disinflates what ultimately happens to the unemployment
rate?
45. How are the effects of the financial crisis shown using the Phillips curve diagram?
46. A central bank disinflates. Output is 4% less for one year, 3% less the next year, and 2% less the third year. If inflation
fell by 2 percentage points, what was the sacrifice ratio?
47. Assuming that rational expectations theory does not hold, if a central banks attempts to reduce the inflation rate what
happens to the unemployment rate in the short-run?
48. A central bank pledges to reduce the inflation rate from 10% to 3%. People reduce their inflation expectations to 5%,
but the central bank reduces inflation to 3%. What happens to the unemployment rate?
49. If there is a decline in business confidence and the Fed desires to return unemployment towards its natural rate, what
should it do? If business confidence eventually returns to normal but the Fed does not reverse its policy, what eventually
happens to the inflation rate?
50. Does a more steeply sloped Phillips curve make the sacrifice ratio smaller or larger than otherwise?
51. Assume the natural rate of unemployment is 6%. Draw the short-run and long-run Phillips curves and show the
position of the economy if expected inflation is 3% and the actual inflation rate is 2%.
52. Assume the natural rate of unemployment is 6%. Draw the short-run and long-run Phillips curves and show the
position of the economy if expected inflation is 3% and the actual inflation rate is 4%.
53. 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?
54. Are the effects of an increase in aggregate demand in the aggregate demand and aggregate supply model consistent
with the Phillips curve? Explain.
55. The Phillips curve and the short-run aggregate supply curve are closely related, yet one slopes downward and the other
slopes upward. Discuss.
56. Explain the connection between the vertical long-run aggregate supply curve and the vertical long-run Phillips curve.
57. Suppose that the Fed 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.
58. What did Friedman and Phelps predict would happen if policymakers tried to move the economy upward along the
Phillips curve? Did the behavior of the economy in the late 1960s and the 1970s prove them wrong?
Inflation rose but unemployment did not remain low.
59. Some countries have inflation around or in excess of 8 percent. Suppose that the sacrifice ratio is 2.5. What is the cost
of reducing inflation from 8 percent to 2 percent? In your answer, define the sacrifice ratio and explain how you found the
cost of inflation reduction.
6 percent = 15 percent of annual output.
60. Why does a downward-sloping Phillips curve imply a positive sacrifice ratio?
positive sacrifice ratio.
61. 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.
62. 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.
63. 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.
64. Suppose that the Prime Minister and Parliament of Veridian are disappointed with the high inflation rates under the
current system where the Veridian Ministry of Finance is in charge of the money supply. They make reforms to lower
inflation from its current rate of 8%. Suppose further that the public is confident that with the reforms in place that
inflation will fall to 2%. Also suppose that those in control of the money supply actually conduct monetary policy so that
the actual inflation rate is 4%. Using long-run and short-run Phillips curves and assuming the natural rate of
unemployment is 6%, show the initial long run equilibrium of Veridian and label it “A”. Assuming that the government
had actually set inflation at 2% and that the public believed this, label the long-run equilibrium “B”. Now, suppose that
inflation expectations fell to 2% and that the government unexpectedly created inflation of 4%. Show the short-run
equilibrium and label it “C”. If the money supply continues to grow at a rate consistent with 4% inflation, show where the
economy ends up and label that point “D”.