Question

a. Use the AD-AS model to derive the short run Phillips curve and show how policy can move the economy from a point with high inflation to appoint with low inflation.

b. Use the AD-AS model to derive the long-run Phillips curve and show the short run and long run effect of a policy that has the goal of reducing the unemployment rate

Answer 1

Inflation TSRAS + EX 7 € Y Y Y Y Real GDP 'Uemployment Rate Here, SRAS> short Run SRPC = Short Run Aggregate Phillips curre! supply

a Let AS be the aggregate supply and AD be the aggregate demand. There is an initial equilibrium price level and real GDP output where AD1=AS. Now there is increases in aggregate demand, causing the curve to shift right to curves AD₂ through AD4. As aggregate demand increases, real output increases, and the price level increases and unemployment decreases. The increase in price level, leads to increase in inflation.

Page No.: Date: 1 b) Price LRA Luptation LRPC AD Real GDP NRy wmendia unemployment. Natural Rate of here, everything same, NRO, Unemployment

b Short run effect : There is an inverse relationship between inflation and unemployment which is shown by the short-run Phillips curve where with increase(decrease) in unemployment leads to decrease(increase) in inflation.

Long run effect : While there is no direct relationship between inflation and unemployment in the long run as the economy stays in full employment, so there is constant unemployment rate with fluctuating inflation rate.