Macroeconomics · Hard · 25 marks
EO past paper: 2022 International Final
Consider an economy with a decreasing short-run Phillips curve. Assume that the actual inflation rate is 2% and the expected inflation rate is also 2%. The natural rate of unemployment is 5%.
(a) Assuming no supply shocks, sketch the situation of this economy in a figure by point A. Use the model of the Phillips curve. (Type your answer: describe the diagram in words, naming the axes, curves, shifts and areas.) [5] marks (b) Suppose that unexpected monetary expansion decreases the actual unemployment rate to 3%. Sketch point B in the graph, using the Phillips curve. Does the inflation rate fall or rise and why? (Type your answer: describe the diagram in words, naming the axes, curves, shifts and areas.) [10] marks (c) Suppose that the government tries to permanently reduce the unemployment rate below the natural level, i.e., to keep it at a 3% level rather than a 5% level. Sketch long-run consequences of this monetary policy in the graph of the Phillips curve and comment on the observed dynamics of the economy. (Type your answer: describe the diagram in words, naming the axes, curves, shifts and areas.) [10] marks
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