An economy has the following equation for the Phillips Curve: π = Eπ − 0.5(u − 6) People form expectations of inflation by taking a weighted average of the previous two years of inflation: Okun’s law for this economy is: Eπ = 0.7π−1 + 0.3π−2 (Y −Y−1)/(Y-1)=3.0−2.0(u−u−1) Th economy begins at its natural rate of unemployment with a stable inflation rate of 5 percent. 1. What is the natural rate of unemployment for this economy? 2. Graph the short-run tradeoff between inflation and unemployment that this economy faces. Label the point where the economy begins as A. 3. A fall in aggregate demand leads to a recession, causing the unemployment rate to rise 4 percentage points above its natural rate. On your graph, label the point the economy experiences that year as point B.
An economy has the following equation for the
π = Eπ − 0.5(u − 6)
People form expectations of inflation by taking a weighted average of the previous two years of inflation:
Okun’s law for this economy is:
Eπ = 0.7π−1 + 0.3π−2
(Y −Y−1)/(Y-1)=3.0−2.0(u−u−1)
Th economy begins at its natural rate of
1. What is the natural rate of unemployment for this economy?
2. Graph the short-run tradeoff between inflation and unemployment that this economy faces. Label the point where the economy begins as A.
3. A fall in aggregate demand leads to a recession, causing the unemployment rate to rise 4 percentage points above its natural rate. On your graph, label the point the economy experiences that year as point B.
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