Read parts (i) to (iii) before answering. Answer all three parts on a single diagram. Assume that the economy experiences no change in productivity, money demand or its natural rate of unemployment in either the short or long run. The inflation rate responds immediately to correspond to the money supply growth rate. However, wage inflation adjusts to changes in the inflation rate with a time lag. (i) Draw a diagram with inflation on the vertical axis and the unemployment rate on the horizontal axis that illustrates the Phillips curve relationship in the short run. Label the curve as PC1. Mark a point N on the horizontal axis that represents the natural rate of unemployment. (ii) Assume that the economy is initially on the curve PC1 at the natural rate of unemployment, with a 5 % rate of increase in the money supply and a 5% inflation rate. Mark point A on the curve PC1 which you would expect to observe if there was an unexpected increase in the rate of growth of the money supply to 10%. (iii)Assume that the new 10% rate of growth in the money supply in part (ii) turns out to be a permanent increase in the rate of growth of the money supply. Draw a new short run curve PC2 which you would expect to observe in the long run. Mark point B on the new curve PC2 that a monetarist would expect to observe in the long run, other things being equal. Also show the long run Phillips curve LRPC.
Question 6
Read parts (i) to (iii) before answering. Answer all three parts on a single diagram. Assume that the economy experiences no change in productivity, money demand or its natural rate of
(i) Draw a diagram with inflation on the vertical axis and the unemployment rate on the horizontal axis that illustrates the Phillips curve relationship in the short run. Label the curve as PC1. Mark a point N on the horizontal axis that represents the natural rate of unemployment.
(ii) Assume that the economy is initially on the curve PC1 at the natural rate of unemployment, with a 5 % rate of increase in the money supply and a 5% inflation rate. Mark point A on the curve PC1 which you would expect to observe if there was an unexpected increase in the rate of growth of the money supply to 10%.
(iii)Assume that the new 10% rate of growth in the money supply in part (ii) turns out to be a permanent increase in the rate of growth of the money supply. Draw a new short run curve PC2 which you would expect to observe in the long run. Mark point B on the new curve PC2 that a monetarist would expect to observe in the long run, other things being equal. Also show the long run Phillips curve LRPC.
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