Just the question in red brackets please thanks! 3. Expectations and the Phillips curveThe following graph shows an economy in long-run equilibrium at point A (grey star symbol). The vertical line is the long-run Phillips curve (LRPC).The downward-sloping curve labeled SRPC, is the short-run Phillips curve passing through point A.SRPCLRPC7SRPC,321235 6478UNEMPLOYMENT RATE (Percent)Which of the following is true along SRPC, ?The actual unemployment rate is 6%.The expected inflation rate is 5%.The actual inflation rate is 5%.The natural rate of unemployment is 3%.Suppose that the Fed suddenly and unexpectedly decreases the money supply in an effort to reduce inflation. As a result of this unanticipated action,actual inflation falls to 3%.On the previous graph, use the black point (plus symbol labeled "B") to illustrate the short-run effects of this policy.INFLATION RATE (Percent) Now, suppose that-after a period of 3% inflation-households and firms begin to expect that the inflation rate will continue to be 3%.On the previous graph, use the purple line (diamond symbol) to draw SRPC2, the short-run Phillips curve that is consistent with these expectations,assuming that it is parallel to SRPC.Finaly, using the orange point (square symbol labeled "C"), indicate on the previous graph the new, long-run equilibrium for this economy.The inflation rate at point Cis higher thanthe inflation rate at point A, and the unemployment rate at point C is the same astheunemployment rate at point A.Was the Fed able to achieve its goal of lowering inflation?O No, because the Fed cannot affect the inflation rate through monetary policy.Yes, but only in the short run; in the long run, inflation returned to its natural rate.Yes, the Fed's policy successfully reduced inflation in both the short run and the long run.Now, suppose that the public fully anticipates the Fed's decision to decrease the money supply. Assume the public also believes that the Fed is firmlycommitted to carrying out this policy. According to rational expectations theory, when the economy is in long-run equilibrium, a fully anticipateddecrease in the money supply will cause the economy to moveon the previous Phillips curve graph. Inthis case, rational expectations theory predicts that the fully anticipated decrease in the money supply will have the immediate effect ofin the inflation rate andin the unemployment rate.

Philips curve shows the inverse relationship between the inflation rate and the unemployment rate. The long-run Phillips curve shows natural unemployment which is the unemployment rate when the economy is at full potential level. The graph has been labeled correctly. Given the SRPC1 and LRPC intersect at 5%, the expected inflation would be 5%. Also, the natural rate of unemployment is 4% ie where the vertical LRPC is situated. So option B) is correct. Now given that actual inflation falls to 3%, the SRPC shifts down to SRPC2. This intersection is labeled as C which is parallel and downwards to A, which was the earlier level of the economy. So the inflation at point C is lower than at point A because point A is higher on the graph. Since both of them lie on the LRPC, the natural rate of unemployment, hence the level of unemployment is the same for both points A and C. Yes, Fed, achieved its goal of lowering inflation. But as seen in the figure, the inflation is reduced for short run. In long run, it would be back at the natural rate as the change in inflation is temporary. So option B) is the answer. Now that the people were able to anticipate the decision of lowering the money supply by the Fed, they would follow the rational expectation theory. So now people have anticipated that the inflation would fall to 3%, the decrease in the money supply would cause the economy to move from A to C. This implies that in the case when rational expectation theory is able to predict, then a fully anticipated decrease in the money supply would have an immediate effect of a decrease in inflation rate and no change in the unemployment rate. This is because when the economy moves from A to C, then it is only causing a reduction in inflation due to the downward shift of the SRPC, but the unemployment rate is still the same. Option B) is correct : Expected inflation rate is 5% Option B) is the correct: Yes, but only in the short run; in the long run, inflation returned to its natural rate.

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The following graph shows an economy in long-run equilibrium at point A (grey star symbol). The vertical line is the long-run Phillips curve (LRPC). The downward-sloping curve labeled SRPC₁ is the short-run Phillips curve passing through point A.

The following graph shows an economy in long-run equilibrium at point A (grey star symbol). The vertical line is the long-run Phillips curve (LRPC). The downward-sloping curve labeled SRPC₁ is the short-run Phillips curve passing through point A.

ENGR.ECONOMIC ANALYSIS

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ISBN:9780190931919

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Publisher:NEWNAN

Chapter1: Making Economics Decisions

Section: Chapter Questions

Problem 1QTC

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Question

Just the question in red brackets please thanks!

3. Expectations and the Phillips curve
The following graph shows an economy in long-run equilibrium at point A (grey star symbol). The vertical line is the long-run Phillips curve (LRPC).
The downward-sloping curve labeled SRPC, is the short-run Phillips curve passing through point A.
SRPC
LRPC
7
SRPC,
3
2
1
2
3
5 6
4
7
8
UNEMPLOYMENT RATE (Percent)
Which of the following is true along SRPC, ?
The actual unemployment rate is 6%.
The expected inflation rate is 5%.
The actual inflation rate is 5%.
The natural rate of unemployment is 3%.
Suppose that the Fed suddenly and unexpectedly decreases the money supply in an effort to reduce inflation. As a result of this unanticipated action,
actual inflation falls to 3%.
On the previous graph, use the black point (plus symbol labeled "B") to illustrate the short-run effects of this policy.
INFLATION RATE (Percent)

Now, suppose that-after a period of 3% inflation-households and firms begin to expect that the inflation rate will continue to be 3%.
On the previous graph, use the purple line (diamond symbol) to draw SRPC2, the short-run Phillips curve that is consistent with these expectations,
assuming that it is parallel to SRPC.
Finaly, using the orange point (square symbol labeled "C"), indicate on the previous graph the new, long-run equilibrium for this economy.
The inflation rate at point Cis higher than
the inflation rate at point A, and the unemployment rate at point C is the same as
the
unemployment rate at point A.
Was the Fed able to achieve its goal of lowering inflation?
O No, because the Fed cannot affect the inflation rate through monetary policy.
Yes, but only in the short run; in the long run, inflation returned to its natural rate.
Yes, the Fed's policy successfully reduced inflation in both the short run and the long run.
Now, suppose that the public fully anticipates the Fed's decision to decrease the money supply. Assume the public also believes that the Fed is firmly
committed to carrying out this policy. According to rational expectations theory, when the economy is in long-run equilibrium, a fully anticipated
decrease in the money supply will cause the economy to move
on the previous Phillips curve graph. In
this case, rational expectations theory predicts that the fully anticipated decrease in the money supply will have the immediate effect of
in the inflation rate and
in the unemployment rate.

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