Question

In the year 2023, aggregate demand and aggregate supply in the fictional country of Gizmet are represented by the curves AD2023${\mathit{AD}}_{2023}$ and AS on the following graph. The price level is 102. The graph also shows two possible outcomes for 2024. The first potential aggregate-demand curve is given by the ADA${\mathit{AD}}_{\mathrm{A}}$ curve, resulting in the outcome illustrated by point A. The second potential aggregate-demand curve is given by the ADB${\mathit{AD}}_{\mathrm{B}}$ curve, resulting in the outcome illustrated by point B.

Suppose the unemployment rate is 7% under one of these two outcomes and 5% under the other. Based on the previous graph, you would expect   (outcome A/ outcome B)to be associated with the higher unemployment rate (7%).

If aggregate demand is low in 2024, and the economy is at outcome A, the inflation rate between 2023 and 2024 is   ( 4%/ 1.96%/2.94%/5%) .

Based on your answers to the previous questions, on the following graph use the purple point (diamond symbol) to plot the unemployment rate and inflation rate if the economy is at point A. Next, use the green point (triangle symbol) to plot the unemployment rate and inflation rate if the economy is at point B. (As you place these points, dashed drop lines will automatically extend to both axes.) Finally, use the black line (cross symbol) to draw the short-run Phillips curve for this economy in 2024.

Hint: Click on each point after you plot it to make sure you have placed it on the exact coordinate you intended.

Suppose that the government is considering enacting an expansionary policy in 2023 that would shift aggregate demand in 2024 from ADA${\mathit{AD}}_{\mathrm{A}}$ to ADB${\mathit{AD}}_{\mathrm{B}}$. This would cause a   (movement along/ shift of)the short-run Phillips curve, resulting in   (increase/decrease) in the inflation rate and   (decrease/ increase) in the unemployment rate.

Answer 1

We can expect 7% unemployment with AD(A) and 5% unemployment with AD(B) as AD(B) has higher output and employment. For the inflation rate between 2020 and 2021, the change in price level is 2. The inflation rate is 2*100/102 = 1.96%

For inflation rate between 2020 and 2021 for high AD(B), the change in price level is 3 so the inflation rate is 3*100/102 = 2.94% An expansionary fiscal policy will cause a movement along the Phillips curve, resulting in a rise in inflation and fall in the unemployment rate

Point A has unemployment rate = 7% and inflation = 1.94%. Point B has unemployment = 5% and inflation = 2.94%