The Short Run Trade Off between Inflation and Unemployment TRUE FALSE 1 2 In the long run the natural rate of unemployment depends primarily on the growth rate of the money supply ANS F In the long run the inflation rate depends primarily on the growth rate of the money supply ANS T 3 Short run outcomes in the economy can be expressed in terms of output and the price level or in 4 Other things the same an increase in aggregate demand reduces unemployment and raises terms of unemployment and inflation ANS T inflation in the short run ANS T by a lower unemployment rate in the short run ANS T the unemployment rate above its natural rate ANS F 5 A given short run Phillips curve shows that an increase in the inflation rate will be accompanied 6 The short run Phillips curve indicates that expansionary monetary policy will temporarily raise 7 The logic behind the tradeoff between inflation and unemployment is that high aggregate demand puts upward pressure on wages and prices while raising output ANS T 8 Unexpectedly high inflation reduces unemployment in the short run but as inflation expectations adjust the unemployment rate returns to its natural rate ANS T 9 Fiscal policy cannot be used to move the economy along the short run Phillips curve 10 If the Fed were to increase the money supply inflation would increase and unemployment would ANS F decrease in the short run ANS T ANS F dichotomy ANS T ANS F 11 Friedman and Phelps believed that the natural rate of unemployment was constant 12 The long run Phillips curve is consistent with monetary neutrality implied by the classical 13 The short run Phillips curve is based on the classical dichotomy 14 The classical notion of monetary neutrality is consistent both with a vertical long run aggregate supply curve and with a vertical long run Phillips curve ANS T 15 Although monetary policy cannot reduce the natural rate of unemployment other types of government policies can ANS T 16 A policy change that reduces the natural rate of unemployment shifts both the long run aggregate supply curve and the long run Phillips curve left ANS F 17 An increase in the natural rate of unemployment shifts the long run Phillips curve to the right 18 In the long run people come to expect whatever inflation rate the Fed chooses to produce so 19 The analysis of Friedman and Phelps argues that an expected change in inflation has no impact 20 In the Friedman Phelps analysis when inflation is less than expected the unemployment rate is 21 According to the Friedman Phelps analysis in the long run actual inflation equals expected ANS T unemployment returns to its natural rate ANS T on the unemployment rate ANS T less than the natural rate ANS F inflation and unemployment is at its natural rate ANS T the long run Phillips curve ANS T 22 An increase in inflation expectations shifts the short run Phillips curve right and has no effect on 23 A decrease in government expenditures serves as an example of an adverse supply shock 24 An adverse supply shock shifts the short run Phillips curve right and the short run aggregate 25 In most of the 1970s the Fed s policy created expectations of high inflation 26 The proliferation of Internet usage serves as an example of a favorable supply shock 27 A decrease in the growth rate of the money supply eventually causes the short run Phillips curve 28 The sacrifice ratio is the percentage point increase in the unemployment rate created in the process of reducing inflation by one percentage point ANS F 29 A low sacrifice ratio would make a central bank less willing to reduce the inflation rate 30 Proponents of rational expectations argue that failing to account for peoples revised inflation expectations led to estimates of the sacrifice ratio that were too high ANS T ANS F supply curve left ANS T ANS T ANS T to shift right ANS F ANS F 31 The sacrifice ratio of the Volcker disinflation was larger than previous estimates had predicted 32 32 U S monetary policy in the early 1980s reduced the inflation rate by more than half ANS F ANS T SHORT ANSWER 1 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 ANS In the long run the natural rate of unemployment is primarily determined by labor market factors including government policy concerning minimum wages and unemployment benefits In the long run inflation is primarily determined by money supply growth These determinants are consistent with the classical dichotomy which states that real and nominal variables are determined independently 2 Are the effects of an increase in aggregate demand in the aggregate demand and aggregate supply model consistent with the Phillips curve Explain ANS Consider what happens when the aggregate demand curve shifts For example suppose there is an increase in aggregate demand The aggregate demand and supply model shows that prices and output will rise Rising prices mean that there is inflation Rising output means falling unemployment Thus a shift in the aggregate demand curve along the aggregate supply curve corresponds to a movement along the Phillips curve 3 The Phillips curve and the short run aggregate supply curve are closely related yet one slopes downward and the other slopes upward Discuss ANS The Phillips curve shows the relation between inflation and unemployment The short run aggregate supply curve shows the relation between the price level and output When aggregate demand increases the price level and output rise The rising price level means that inflation has increased The rising level of output means that firms will hire more workers so that the unemployment rate falls Thus the model implies that inflation and unemployment are inversely related as the Phillips curve indicates Real GDP and the unemployment rate move in the opposite direction So it is consistent to have an upward sloping aggregate supply curve with output on the horizontal axis and a downward sloping Phillips curve with unemployment on the horizontal axis 4 Explain the connection between the vertical long run aggregate supply curve and the vertical long run Phillips curve ANS Both reflect the classical dichotomy The vertical long run aggregate supply curve says that in the long run the economy will be at its natural rate of output and that this is the same no matter what the price level The natural rate of output depends on the natural rate of