Download 29 U.S. INFLATION, UNEMPLOYMENT, AND BUSINESS CYCLES**

C h a p t e r
29
U.S. INFLATION,
UNEMPLOYMENT,
AND BUSINESS
CYCLES**
Solutions to the Odd-Numbered Problems
1.
a.
b.
c.
d.
3.
a.
b.
c.
5.
a.
b.
*
Argentina experienced inflation in 1994, 1995, 2000, 2002, 2003, and 2004. Argentina
experienced deflation in 1997, 1998, 1999, and 2001.
Argentina had recessions in 1995, 2000, 2001, and 2002. Argentina had expansions in 1994,
1996, 1997, 1998, 2003, and 2004.
The unemployment rate was probably high in all of the recessionary years. It was probably
the highest in 2000 and 2002 when the recessions were the most severe.
There is not a strong relationship between unemployment and inflation in the data. The
unemployment rate would likely have been high in 1995, 2000, 2001, and 2002. In 1995,
2000, and 2002 Argentina experienced inflation while in 2001 Argentina experienced
deflation. So there is no consistent relationship between either inflation and high
unemployment or deflation and high unemployment. There also is a similar lack of
relationship between inflation and low unemployment or deflation and low unemployment.
Anything that decreases short-run aggregate supply can set off a cost-push inflation. For
instance, an increase in the money wage rate, an increase in the money price of raw materials
could all be the start of a cost-push inflation. But to sustain such an inflation, the quantity of
money must keep increasing.
Starting out on AD0 and SAS0, the price level is 120 and real GDP is at potential GDP of $10
trillion. Short-run aggregate supply decreases and the SAS curve shifts leftward to SAS1. The
price level rises and real GDP decreases to the intersection of AD0 and SAS1. There is now a
recessionary gap.
Starting out on AD0 and SAS1 with a recessionary gap, real GDP is below potential GDP and
unemployment is above the natural rate. In an attempt to restore full employment, the central
bank increases the quantity of money. The aggregate demand curve shifts rightward to AD1.
Real GDP returns to $10 trillion and the price level rises to 160. A further cost increase
occurs, which shifts the short-run aggregate supply curve to SAS2 and a recessionary gap
opens up again. The economy is again below potential GDP. In an attempt to restore full
employment, the central bank increases the quantity of money. The aggregate demand curve
shifts rightward to AD2. Real GDP returns to $10 trillion and the price level rises to 200.
People expect that the price level will fall. The money wage rate falls in expectation of the
lower price level. The short-run aggregate supply curve shifts rightward. There is no change
in potential GDP. The long-run aggregate supply curve does not shift.
Starting out on AD0 and SAS0, the price level is 120 and real GDP is at potential GDP of $10
trillion. Short-run aggregate supply increases, and the SAS curve shifts rightward . The
aggregate demand curve does not shift. The price level falls, but by less than people
expected. Real wages fall because money wages have fallen by more than the price level.
Real GDP increases. Real GDP is greater than potential GDP and an inflationary gap opens.
* This is Chapter 13 in Macroeconomics.
1
c.
7.
a.
b.
c.
2
The money wage rate rises to reflect the higher expected price level. The rise in money
wages decreases the short-run aggregate supply and the SAS curve shift leftward to SAS0.
The price level rises to 120 and the economy returns to its potential GDP.
First the inflation rate increases from 5 percent to 15 percent and the unemployment rate
does not change. Then the unemployment rate increases from 4 percent to 8 percent and the
inflation rate does not change. Next the inflation rate falls from 15 percent to 5 percent and
the unemployment rate does not change. Finally the unemployment rate falls from 8 percent
to 4 percent and the inflation rate does not change. This set of changes could be the result of
an expected increase in the inflation rate from 5 percent to 15 percent, followed by an
increase in the natural unemployment rate from 4 percent to 8 percent, followed by an
expected fall in the inflation rate from 15 percent to 5 percent, finally followed by a decrease
in the natural unemployment rate from 8 percent to 4 percent.
The initial increase in the expected inflation rate moves the economy up its (stationary) longrun Phillips curve from point A to point B. The short-run Phillips curve shifts upward to
intersect the long-run Phillips curve at point B. Then the increase in the natural
unemployment rate shifts both the long-run and short-run Phillips curves rightward so that
they both reach point D. Next the fall in the expected inflation rate moves the economy
along its (stationary) new long-run Phillips curve from point D to point C. The short-run
Phillips curve shifts downward to intersect the long-run Phillips curve at point C. Finally, the
fall in the natural unemployment rate shifts both the long-run and short-run Phillips curves
rightward so that they both reach point A.
The economy has experienced expected inflation, the movement from point A to point B, and
expected deflation, the movement from D to point C.