Question

Consider a hypothetical economy that is at a short run and long run equilibrium. Suppose that in this economy, there is a change in the regulation of the labor market This change in regulation makes it easier for employers to hire and fire people, thus reducing frictional unemployment. Assume further that there is no change in people’s inflation expectations after this. Considering the Phillips Curve, answer what will happen to:
i)    The inflation rate.
ii)    The unemployment rate.
In the long run, for this economy.

		The inflation rate goes down; the unemployment rate goes down.
		The inflation rate goes up; the unemployment rate goes down.
		The inflation rate goes up; the unemployment rate goes up.
		The inflation rate goes down; the unemployment rate goes up.

Answer 1

Inflation goes down and unemployment rises

Short-run: Firms experiencing losses cut down costs by laying off people. This enhances the rate of unemployment. And hence inflation goes down because of less income of people and same level of production in the short run.

Longrun: New firms enter lured of profits and ease of doing business and unemployment lessens to some extent. Firms production in economy is also aligned towards demand and inflation level comes to normal