The Phillips curve and the short-run aggregate supply curve are closely related, yet one slopes downward and the other slopes upward. Discuss


Q5. Use the AD-AS and the Philips curve diagrams to show the short-run effects on prices (inflation) and output (unemployment) with following scenarios



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Q5. Use the AD-AS and the Philips curve diagrams to show the short-run effects on prices (inflation) and output (unemployment) with following scenarios:

  1. Government expenditures increase: AD↑ => P↑ and Y↑ => Inflation rate↑ and U-rate↓

  2. Businesses become less optimistic about the future: AD↓ => P↓ and Y↓ => Inflation rate↓ and u-rate↑

  3. Consumer confidence rises: AD↑ => P↑ and Y↑ => Inflation rate↑ and U-rate↓

  4. Net exports fall due to recessions in foreign countries: AD↓ => P↓ and Y↓ => Inflation rate↓ and u-rate↑

  5. If the Central Bank wanted to reverse the effects of those shocks on output (senarios (a) to (d)), what should it do? For each senario, explain and show in the AD-AS and the Philips curve diagrams.

    1. Reduce money supply => AD↓ => P↓ and Y↓ => Inflation rate↓ and u-rate↑

    2. Increase money supply => AD↑ => P↑ and Y↑ => Inflation rate↑ and U-rate↓

    3. Reduce money supply => AD↓ => P↓ and Y↓ => Inflation rate↓ and u-rate↑

    4. Increase money supply => AD↑ => P↑ and Y↑ => Inflation rate↑ and U-rate↓

  6. Assume that the Central Bank now do nothing, In order to maintain output what would government do with fiscal policy in response to those scenarios? Explain and show in the AD-AS and the Philips curve diagrams.

    1. Reduce government spending => AD↓ => P↓ and Y↓ => Inflation rate↓ and u-rate↑

    2. Increase government spending => AD↑ => P↑ and Y↑ => Inflation rate↑ and U-rate↓

    3. Reduce government spending => AD↓ => P↓ and Y↓ => Inflation rate↓ and u-rate↑

    4. Increase government spending => AD↑ => P↑ and Y↑ => Inflation rate↑ and U-rate↓

Inflation rate


P



AS



A



B

A



B



PC

AD1



AD2



0

Unemployment rate

Y

0

5a, 5c, 6a, 6c



Inflation rate


P



AS



B



B

A





A

AD2



PC

AD1



Natural rate of unemployment

0

Unemployment rate

Y

0


5b, 5d, 6b, 6d

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