Chapter 16: Quiz Answers -- The Phillips Curve

1. The Phillips Curve is a graphical depiction of the
   negative relationship between inflation and unemployment. This is true by definition.

2. The long-run Phillips Curve is vertical which indicates
   that in the long-run, there is no tradeoff between inflation and unemployment. With a vertical Phillips curve, any inflation rate is consistent with the given unemployment rate.

3. If the Aggregate Demand curve shifts to the left,
   the economy moves down and to the right on the short-run Phillips Curve. A leftward shift of the Aggregate Demand curve results in a lower price level and lower output. These changes to lower inflation and higher unemployment on the Phillips curve, which results from a movement down and to the right on the Phillips Curve.

4. When the economy is on the long-run Phillips Curve, we know that
   All of the above. The long-run Phillips Curve is consistent with the economy's long-run equilibrium level of output, which is the natural rate of unemployment.

5. Given the equation for the Phillips Curve: inflation rate = b(U* - U) + P^e,
   if b = 0.5, U* = 5.0, U = 6.0, and Pe = 3, then the current rate of inflation is
   2.5%. inflation rate = 0.5(5.0% - 6.0%) + 3% = 2.5%

6. From the equation above in question five, we know that the rate of inflation in the long run would be
   3.0%. We know this because in the long run U = U*, so
   inflation rate = 0.5 (5% - 5%) + 3% = 3%.

7. The short-run Phillips Curve shifts upward when
   there is a rise in inflation expectations. Given the natural rate of unemployment (U*), an increase in P^e increases the inflation rate for every level of actual unemployment.

8. The short-run Phillips curve seemed to break down once again in the 1990s. A possible explanation for this breakdown is
   an increase in labor productivity. An increase in labor productivity relieves some of the inflation pressure resulting from falling unemployment. As unemployment rates fall, wages tend to rise. Rising labor productivity, however, allows firms to pay those higher wages without necessarily having to raise prices because the workers are more productive.

9. An oil shock can cause stagflation, a period of higher inflation and higher unemployment. When this happens, the economy moves to a point to the northeast of where it currently is. After the economy has moved to the northeast, the Federal Reserve can reduce that inflation without having to worry about causing more unemployment.
   False. In the short run, a tradeoff exists between inflation and unemployment. After the oil shock, if the Fed takes steps to lower inflation, the economy's level of unemployment will rise.

10. A shift in the Aggregate Supply curve to the right will result in a move to a point that is southwest of where the economy is currently at.
    True. The shift in Aggregate Supply to the right leads to lower prices and higher output. In the Phillips, this shift translates into lower inflation and unemployment, which the economy achieves as it moves to the southeast in the Phillips curve graph.