Question

Answer the questions below on the basis of the following data

	actual inflation	expected inflation
Point A	3%	2%
Point B	4%	4%
Point C	2%	4%

A. Suppose the equation describing the Phillips curve is π = π e − 2(U − 5). For each of the points: A, B, and C, calculate the unemployment rate. Show all your work.

B. Based on the equation in part a, what is the numerical value of the natural rate of unemployment? Explain how you know.

Answer 1

A) Given that Phillips curve is π = π e − 2(U − 5)

Point A

π = π e − 2(U − 5)

0.03=0.02-2U+10

U=4.995

Point B

π = π e − 2(U − 5)

0.04=0.04-2U+10

U =5

Point C

π = π e − 2(U − 5)

0.02=0.04-2U+10

U=5.01

B) If the inflation rate is steady, then the expected inflation will equal the actual inflation rate, and the unemployment rate will equal the natural unemployment rate.

The natural rate of unemployment represents the lowest unemployment rate whereby inflation is stable or the unemployment rate that exists with non-accelerating inflation.

So, the numerical value of the natural rate of unemployment is 5