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Tutorial 9 Chapter 14

The document discusses the relationship between the Phillips curve and aggregate supply. It explains that the Phillips curve provides an alternative way to express short-run aggregate supply and implies a tradeoff between inflation and unemployment. It also discusses demand-pull inflation and cost-push inflation as well as how recessions can impact the natural rate of unemployment.

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Renee Wong
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29 views2 pages

Tutorial 9 Chapter 14

The document discusses the relationship between the Phillips curve and aggregate supply. It explains that the Phillips curve provides an alternative way to express short-run aggregate supply and implies a tradeoff between inflation and unemployment. It also discusses demand-pull inflation and cost-push inflation as well as how recessions can impact the natural rate of unemployment.

Uploaded by

Renee Wong
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as DOCX, PDF, TXT or read online on Scribd
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Q2. How is the Phillips curve related to aggregate supply?

Short run aggregate supply (SRAS) depends on natural rate of output (Y) and the difference
between price level and expected price level (P-EP). Hence, SRAS: Y =Y + (P-EP).

Philips curve is an alternative way to express aggregate supply. It provides a simple way to
express short-run tradeoff between inflation and unemployment implied by SRAS.

Phillips curve posits that inflation () depends on expected inflation rate (E), on cyclical
unemployment (u-un), and on supply shock (). Hence, Philips curve:  = E - (u-un) + 

Both imply that:


i) Relationship between real economic activity and unexpected changes in prices
ii) Both inflation and unemployment move in opposite direction

**Tradeoff relationship will only be seen in short-run.

Q4. Explain the differences between demand-pull inflation and cost-push inflation.
Demand-pull inflation arises due to the increase in aggregate demand, while cost-push inflation
arises due to the increase in production cost. Since Philips curve express inflation as  = E -
(u-un) + , “-(u-un)” describes demand-pull inflation, whereas “” expresses cost-push
inflation.

Q6. Explain two ways in which a recession might raise the natural rate of unemployment.
i) By affecting the process of job search, increasing the number of frictional unemployment.
Losing job skills for example, causes it difficult to find a job after recession.
ii) By affecting wages, that is wage stickiness. Non-members (outsiders) may be unemployed
during recession while insiders (members) may have power to push real wage above
equilibrium wage level. This causes structural unemployment.

P2. Suppose that an economy has the Phillips curve π = π−1− 0.5(u− 5).
a) What is the natural rate of unemployment?
Natural rate of unemployment = 5% (0.05)

b) Graph the short-run and long-run relationships between inflation and unemployment.
In the short-run, inflation & unemployment relationship has a slope of -0.5, passes through
the point where π = π−1 and unemployment is 0.05.

c) How much cyclical unemployment is necessary to reduce inflation by 4 percentage


points? Using Okun’s law, compute the sacrifice ratio.
For inflation to fall by 4%, π – π−1 = -4% (-0.04)
-0.04 = -0.5 (u – 0.05)
U = 0.13 (13%)
d) Inflation is running at 6 percent. The central bank wants to reduce it to 2 percent. Give
two scenarios that will achieve that goal.

**LRPC = LRAS

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