Question

Question 3. (18 marks) Economists use the model of aggregate demand and aggregate supply to explain downward sloping Phillips curve. Elaborate using appropriate graph.

Answer 1

The aggregate demand and supply show a short-run relationship between the price level and output whereas the Phillips curve shows the short-run relationship between inflation and unemployment.

Situation 1- When aggregate demand is low(AD1), that is point A the output and price level are low.

Situation 2 -When aggregate demand is high(AD2), that is point B the output and price level is high.

If we see the implication of this change on the Phillips Curve we see point A where aggregate demand is low unemployment is high(7%) with reduced inflation(2%). Whereas in point B where aggregate demand is high the unemployment falls(4%) whereas the inflation increases (6%)hence satisfying the tradeoff stated in the Phillips curve.

AD-AS Model Philips Curie Price 1 Inflation herel Rate AS 106=82 ON 3 102=P, AD2 AD, 27 72 T unemploymento* +15,000 16,000 4% 4% 7% Y= 16,000 Y 15,00 Output Unemploy Rate ICScanned with CamScanner

AD-AS Model Philips Curie Price 1 Inflation herel Rate AS 106=82 ON 3 102=P, AD2 AD, 27 72 T unemploymento* +15,000 16,000 4% 4% 7% Y= 16,000 Y 15,00 Output Unemploy Rate ICScanned with CamScanner