Question

•Chapter 14 – Aggregate Supply SRAS: Y = Y ̅ + α(P-EP) with α >0; firms’ desired price p = P + a(Y-Y ̅) a > ?; Phillips Curve: π=Eπ- β(u-u^n )+ v; curves, what shifts PC, adaptive expectations

1.What happens to inflation if we have unemployment greater than the natural rate?

2.What happens to inflation if we have a really bad supply shock?

3.Relate (1) and (2) to AD/AS; do we get similar answer?

Answer 1

Answer 1;

1. High unemployment rate in the economy greater than the natural rate will lead to low inflation rate in the economy. This is because wages will decline and thus overall aggregate demand declines. This leads to fall in inflation rate in the economy. Philips curve equation also shows a negative relationship between chnage in inflation rate and unemployment rate in the economy.

2. A bad supply shock will lead to increase in the inflation rate of the economy as the equation above shows.

c. yes, both will give similar answer in case of AS/ AD.