Question

1) If an economy has a horizontal Phillips curve and experiences a recession, inflation:

a. falls.

b.does not change.

c.rises sharply.

d.rises, but not very much.

e.falls sharply.

2)According to the Phillips curve, in general during an expansion

a.inflation rises.

b.inflation falls.

c.unemployment falls.

d.inflation is constant.

e.prices fall.

3)If prices are flexible (as in the long run) and the Fed lowers the nominal interest rate (ceteris paribus), __________ and, as a result, __________.

a.the real interest rate falls; short-run real output rises

b.the real interest rate rises; short-run real output falls

c.the unemployment rate rises; short-run real output rises

d.the real interest rate remains constant; real output remains at potential

4) If prices are sticky and the Fed raises the nominal interest rate (ceteris paribus), __________ and, as a result, __________.

a.the real interest rate remains constant; real output remains at potential

b.the real interest rate falls; short-run real output rises

c.the unemployment rate rises; short-run real output rises

d.the real interest rate rises; short-run real output falls

Answer 1

1.b) Inflation does not change. As the curve is horizontal, it means that inflation remains the same with changes in unemployment so there will be no change in inflation even when the economy goes into a recession.

2. a) During expansion, the economy is boosted so inflation rises.

3.a) When Feds lower the nominal interest rate, the real interest rate will decrease by Fisher's equation(prices are also flexible in the long-run so inflation exists). Due to low-interest rates, investment increases and this drives up the short-run real output.

4. d) As inflation is constant, the rise in nominal interest rate would increase the real interest rate by Fisher's equation. This will reduce investment and lower output.