Answered: Suppose that the Phillips curve is…

ENGR.ECONOMIC ANALYSIS

14th Edition

ISBN:9780190931919

Author:NEWNAN

Publisher:NEWNAN

Chapter1: Making Economics Decisions

Section: Chapter Questions

Problem 1QTC

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Question

Suppose that the Phillips curve is given by
π t = π te − α ( u t − u n ) ,
where the estimated value of the natural rate of unemployment, un = 4.5% and α = 0.4. The expectations are myopic (i.e. fully backward), thus πte = πt−1.
a) What is the sacrifice ratio in this economy? Explain in words.
Suppose that at time t = 0 unemployment is initially equal to the natural rate (i.e. u0 = 4.5%) and π0 = 7.5%. The central bank decides that 7.5% inflation is too high and that starting in year 1 it will decrease inflation to 3.5%.

Definition Definition Relationship between the rate of unemployment and the rate of inflation that shows that the lower the initial rate of unemployment, the greater the rise in wage rate corresponding to a given rise in the rate of unemployment. The Phillips curve assumes that the ratio between prices and nominal wage rates is constant in the short run. Presented graphically, the Phillips curve shows an inverse relationship between the rate of unemployment and the rate of inflation.

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