Question

30. Suppose that the natural rate of unemployment equals 6%, and the public expect inflation to equal 4 %, and the coefficient a in PC equation = 0.4.

a. What is the unemployment rate when the actual inflation equals 2%? What if the actual inflation rate equals 10%?

b. During the 1990s, we observed the co-existence of low inflation and low unemployment. One of the arguments given by macroeconomists is that the expected inflation was lower than usual during the 1990s. Suppose now the public expect inflation rate to be 2%, do question (a) again.

c. Draw the long-run Phillips curve and the short-run Phillips curve corresponding to question (a) and that corresponding to question (b).

Answer 1

A) When actual and expected inflation are equal, unemployment Equal to natural rate of unemployment.

Each excess one percentage point inflation lead to 0.4 percentage Cyclical unemployment.

Actual inflation 2%

Excess inflation=2-4=-2%

Cyclical unemployment=-2*-0.4=0.8%

Unemployment rate=6+0.8=6.8%

Actual inflation=10%

Excess inflation=10-4=6%

Cyclical unemployment=6*-0.4=-2.4%

Unemployment rate=6-2.4=3.6%

B) actual inflation=2%

Excess inflation=2-2=0

Cyclical unemployment=0

Unemployment rate=6%

Actual inflation=10%

Excess inflation=10-2=8%

Cyclical unemployment=8*-0.4=-3.2%

Unemployment rate=6-3.2=2.8%

C) part a)

Part b)