Download Phillips Curve Practice

and other stuff
Manipulating the PC
 Movement along the SRPC caused by change in AD
 Contractionary fiscal or monetary policy will reduce
inflation but increase u%; MOVE DOWN/RIGHT
ALONG THE SRPC
 Expansionary policy will increase inflation but
decrease u%; Move UP/LEFT ALONG THE SRPC
Shifting the PCs
 To shift the SRPC, there will be a change in
inflationary expectations. If people expect more
inflation, they will begin spending money before it
loses value (SRPC shifts right)
 If their inflationary expectations are reduced, they
will spend less/more slowly so money can gain interest
(SRPC shifts left)
 SRPC will shift left with positive supply-side
economics news; will shift right with negative supplyside economics news
 According to the short-run Phillips Curve, there is a
trade-off between
a. interest rates and inflation
b. the growth of the money supply and interest rates
c. unemployment and economic growth
d. inflation and unemployment
e. economic growth and interest rates
 According to the long-run Phillips Curve, which of the
following is true?
 A. Unemployment increases with an increase in
inflation
 B. Unemployment decreases with an increase in
inflation
 C. Increased automation will lead to lower levels of
structural unemployment in the long run
 D. The natural rate of unemployment is independent of
monetary and fiscal policy changes that affect aggregate
demand
 An increase in which of the following will lead to lower
inflation and lower unemployment?
 A. Exports
 B. Aggregate demand
 C. Labor productivity
 D. Government spending
 E. The international value of domestic currency
 Which of the following best explains how an economy
could simultaneously experience high inflation and high
unemployment?
a. the government increases spending without
increasing taxes
b. the government increases taxes without increasing
spending
c. inflationary expectations continue
d. teenagers stay out of the labor force
e. negative supply shocks cause factor prices to
increase.
Practice FRQ (from 2009 exam)
 Assume that the US economy is in long-run
equilibrium with an expected inflation rate of 6% and
an unemployment rate of 5%. The nominal interest
rate is 8%.
 A) Using a correctly labeled graph with both the short-
run and long-run Phillips curves and the relevant
numbers from above, show the current long-run
equilibrium as Point A.
 B) Calculate the real interest rate in the long-run
equilibrium.
 C) Assume that the Federal Reserve decides to target
an inflation rate of 3%. What open-market operation
should the Federal Reserve undertake?
 D)Using a correctly labeled graph of the money
market, show how the Federal Reserve’s action you
identified in part (C) will affect the nominal interest
rate.
 E) How will the interest rate change you identified in
part (D) affect aggregate demand in the short run?
Explain.
 F) Assume that the Federal Reserve action is
successful. What will happen to each of the following
as the economy approaches a new long-run
equilibrium?
(i) the short-run Phillips curve. Explain
(ii) the natural rate of unemployment
The Laffer Curve
 Definition : Laffer curve is a theoretical representation of
the relationship between government revenue raised
by taxation and all possible rates of taxation.
 In a nutshell: At 0% tax rate, revenue is $0; at 100%
taxation, revenue is $0. Tax rates that are too high are a
disincentive to work more. At a certain point of
taxation, revenues actually fall because people will
work less. There is little disagreement on whether or not
the principle is true; arguments arise over the tax rates.
The name?
 Arthur Laffer
 Was in a meeting with Rumsfeld, Cheney, and others
in 1974, arguing against tax increases by Pres. Ford
 He drew it on a cocktail napkin to illustrate it
Key idea
 The Laffer Curve supports supply-side economics,
which asserts that overall economic well-being is
increased when barriers to production are removed.
 These economists believe in low tax rates and
capital gains taxes as a way to encourage
productivity
 A favorite theory of Pres. Reagan
Hallelujah. Pass the Tylenol.
 We’re done.
 Sort of.
 If you are going to take the AP Exam, you need to
make every effort to be here on Friday AND the Macro
Cram Session the night before the exam.
 Wed, 5/11, 6:30-8:30
 Start studying your cards about 20 minutes each night.
Test : Money, Banking, the Fed,
Stabilization
 Functions and characteristics of money
 M1, M2, M3
 Multiple expansion of deposits ; calculate money




multiplier, excess reserves, change in loans (aka
change in money supply through loans), change in
money supply
Equation of exchange
The Fed, purpose and structure
Tools of monetary policy
Real v. nominal interest
Graphs
 AD/AS, LRAS
 Loanable funds (supply/demand!)
 Money market ( supply/demand with vertical money
supply curve)
 Phillips curve, SRPC, LRPC
 Laffer curve
The test
 20 carefully chosen MC questions
 1 bohemoth FRQ
Prepare yourself by
 Studying class notes
 Reviewing flashcards
 Study and practice drawing , labeling, and shifting the
graphs
 BRING YOUR NOTES TO CLASS.