Question

Business Fluctuations: Work It Out 2 of 3 From the equation of exchange, Mr r, we know that spending growth M+7 equals nflation rt Real growth. Recall from the chapter that in the long run (1) the inflation rate is found where the AD curve intersects the LRAS curve (reading off the vertical axis) and (2) the expected inflation rate is found where the short-run aggregate suppl intersects the LRAS curve. With these things in mind, assume that the Solow growth rate is 3% if spending growth equals 696, what will π equal in the long run? What will Er equal? π=

Answer 1

Solow growth rate = 3%
Spending growth rate = 4%
What will $\pi$ be in the long run? What will $E\pi$ be?

M + v = 4% and real growth rate is given as 3%.
Therefore, 4% = inflation + real growth rate
Inflation $\pi$ = 1%
And E$\pi$ = 1% from the graph below (use for analogy, not for values)


Inflation and expected inflation are not necessarily equal. A change in expected inflation shifts the SRAS curve, while a change in inflation causes movement along the curve. In the long run, however, the two may be equal.