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Chapter 36 The Short-Run Trade-Off Between Inflation and UnemploymentMULTIPLE CHOICEINTRODUCTION In the long-run, a. the natural rate of unemployment depends primarily on the level of aggregatedemand. b. inflation depends primarily upon the money supply growth rate. c. there is a tradeoff between th...

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Chapter 36 The Short-Run Trade-Off Between Inflation and Unemployment MULTIPLE CHOICE INTRODUCTION 1. In the long-run, a. the natural rate of unemployment depends primarily on the level of aggregate demand. b. inflation depends primarily upon the money supply growth rate. c. there is a tradeoff between the inflation rate and the natural rate of unemployment. d. All of the above are correct. ANS: B PTS: 1 DIF: 2 REF: 36-0 2. A basis for the slope of the short-run Phillips curve is that when unemployment is high there are a. downward pressures on prices and wages. b. downward pressures on prices and upward pressures on wages. c. upward pressures on prices and downward pressures on wages. d. upward pressures on prices and wages. ANS: A PTS: 1 DIF: 2 REF: 36-0 THE PHILLIPS CURVE 1. In his famous article published in an economics journal in 1958, A.W. Phillips a. used data for the United States to show a negative relationship between the rate of change of the U.S. consumer price index and the U.S. unemployment rate. b. used data for the United States to show a negative relationship between the rate of change of wages in the U.S. and the U.S. unemployment rate. c. used data for the United Kingdom to show a negative relationship between the rate of change of the U.K. consumer price index and the U.K. unemployment rate. d. used data for the United Kingdom to show a negative relationship between the rate of change of wages in the U.K. and the U.K. unemployment rate. ANS: D PTS: 1 DIF: 2 REF: 36-1 2. Samuelson and Solow argued that a combination of low unemployment and low inflation a. was impossible given the historical data as summarized by the Phillips curve. b. could be achieved with an “appropriate” fiscal policy. c. could be achieved with an “appropriate” monetary policy. d. could be achieved with an “appropriate” mix of monetary and fiscal policies. ANS: A PTS: 1 DIF: 2 REF: 36-1

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2 ❖ Chapter 36 /The Short-Run Trade-Off Between Inflation and Unemployment

3. If the central bank decreases the money supply, then in the short-run prices a. rise and unemployment falls. b. fall and unemployment rises. c. and unemployment rise. d. and unemployment fall.

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Chapter 36 /The Short-Run Trade-Off Between Inflation and Unemployment ❖ 3

ANS: B

PTS: 1

DIF: 2

REF: 36-1

4. If policymakers decrease aggregate demand, then in the long-run a. prices will be lower and unemployment will be higher. b. prices will be lower and unemployment will be unchanged. c. prices and unemployment will be unchanged. d. None of the above is correct.

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4 ❖ Chapter 36 /The Short-Run Trade-Off Between Inflation and Unemployment

ANS: B

PTS: 1

DIF: 2

REF: 36-1

5. If the short-run Phillips curve were stable, which of the following would be unusual? a. An increase in government spending and a fall in unemployment. b. An increase in inflation and a decrease in output. c. A decrease in the inflation rate and a rise in the unemployment rate. d. A decrease in the money supply and a rise in the unemployment rate. ANS: B PTS: 1 DIF: 2 REF: 36-1 Figure 36-1. The left-hand graph shows a short-run aggregate-supply (SRAS) curve and two aggregate-demand (AD) curves. The price level is on the vertical axis and the output on the horizontal axis. On the right-hand diagram, U represents the unemployment rate and the vertical axis is the inflation rate. P

Phillips Curve SRAS

A

30

F

B

130 115

G

15 C

D

High AD Low AD 6%

10%

U

6. Refer to Figure 36-1. Suppose points F and G on the right-hand graph represent two possible outcomes for an imaginary economy in the year 2018, and those two points correspond to points B and C, respectively, on the left-hand graph. Also suppose we know that the price index equaled 120 in 2017. Then the numbers 115 and 130 representing price level on the vertical axis of the left-hand graph would have to be replaced by a. 155 and 175, respectively. b. 138 and 156, respectively. c. 137.5 and 154.75, respectively. d. 135 and 150, respectively. ANS: B PTS: 1 DIF: 3 REF: 36-1 7. Refer to Figure 36-1. The curve that is depicted on the right-hand graph offers policymakers a “menu” of combinations a. that applies both in the short-run and in the long-run. b. that is relevant to choices involving fiscal policy, but not to choices involving monetary policy. c. of inflation and unemployment. d. All of the above are correct. ANS: C PTS: 1 DIF: 2 REF: 36-1

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Chapter 36 /The Short-Run Trade-Off Between Inflation and Unemployment ❖ 5

Figure 36-2. The left-hand graph shows a short-run aggregate-supply (SRAS) curve and two aggregate-demand (AD) curves. On the left-hand diagram, Y represents output and on the righthand diagram, U represents the unemployment rate. Phillips Curve SRAS 9%

B

B 156

A

4%

A High AD Low AD

Y

4.5%

7.5%

U

8. Refer to Figure 36-2. Assume the figure charts possible outcomes for the year 2018. In 2018, the economy is at point A on the left-hand graph, which corresponds to point A on the right-hand graph. The price level in the year 2017 was a. 144. b. 150. c. 152. d. 156. ANS: B PTS: 1 DIF: 3 REF: 36-1 9. Refer to Figure 36-2. Assume the figure charts possible outcomes for the year 2018. In 2018, the economy is at point B on the left-hand graph, which corresponds to point B on the right-hand graph. Also, point A on the left-hand graph corresponds to A on the right-hand graph. The price level in the year 2018 is a. 155.56. b. 159.00. c. 163.50. d. 170.04. ANS: C PTS: 1 DIF: 3 REF: 36-1

SHIFTS IN THE PHILLIPS CURVE: THE ROLE OF EXPECTATIONS

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6 ❖ Chapter 36 /The Short-Run Trade-Off Between Inflation and Unemployment

1. In the late 1960s, Milton Friedman and Edmund Phelps argued that a. the trade-off between inflation and unemployment did not apply in the long-run. This claim is consistent with monetary neutrality in the long-run. b. the trade-off between inflation and unemployment did not apply in the long-run. This claim is inconsistent with monetary neutrality in the long-run. c. the trade-off between inflation and unemployment applied in both the short-run and the long-run. This claim is consistent with monetary neutrality in the long-run. d. the trade-off between inflation and unemployment applied in both the short-run and the long-run. This claim is inconsistent with monetary neutrality in the longrun. ANS: A PTS: 1 DIF: 2 REF: 36-2 2. Which of the following leads to a lower level of unemployment in the long-run? a. both an increase in the size of the money supply and an increase in the money supply growth rate. b. an increase in the size of the money supply but not an increase in the money supply growth rate. c. an increase in the money supply growth rate, but not an increase in the size of the money supply d. neither an increase in the size of the money supply nor an increase in the money supply growth rate. ANS: D PTS: 1 DIF: 3 REF: 36-2 3. For a number of years many European countries and Canada have had higher average unemployment rates than the United States. The Phillips curve suggests that these countries a. have higher average inflation rates than the United States. b. have long-run Phillips curves to the right of the United States’. c. may have less generous unemployment compensation or lower minimum wages. d. All of the above are consistent with the evidence on unemployment rates. ANS: B PTS: 1 DIF: 2 REF: 36-2 Figure 36-3 10

Inflation Rate B

A

9 8 7

C

6 5 4 3

D

2 1

1

2

3

4

5

6

7

8

9

10

Unemployment Rate

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Chapter 36 /The Short-Run Trade-Off Between Inflation and Unemployment ❖ 7

4. Refer to figure 36-3. In this order, which curve is a long-run Phillips curve and which is a short-run Phillips curve? a. A, B. b. A, D. c. C, B. d. None of the above is correct. ANS: B PTS: 1 DIF: 1 REF: 36-2 5. If the natural rate of unemployment falls, a. both the short-run Phillips curve and the long-run Phillips curve shift. b. only the short-run Phillips curve shifts. c. only the long-run Phillips curve shifts. d. neither the short-run nor the long-run Phillips curves shift. ANS: A PTS: 1 DIF: 3 REF: 36-2 6. A policy that raised the natural rate of unemployment would shift a. both the short-run and the long-run Phillips curves to the right. b. the short-run Phillips curve right but leave the long-run Phillips curve unchanged. c. the long-run Phillips curve right but leave the short-run Phillips curve unchanged. d. neither the long-run Phillips curve nor the short-run Phillips curve right. ANS: A PTS: 1 DIF: 3 REF: 36-2 Figure 36-4 Use the graph below to answer the following questions. Inflation Rate

Curve 1 F

D C B A Curve 2 Unemployment Rate

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8 ❖ Chapter 36 /The Short-Run Trade-Off Between Inflation and Unemployment

7. Refer to Figure 36-4. The money supply growth rate is greatest at a. A. b. B. c. C. d. F. ANS: D PTS: 1 DIF: 2 REF: 36-2 Figure 36-5 Use this graph to answer the questions below. 12

Inflation

11

Rate

10 9 8 7 6 5 4 3 2 1

1

2

3

4

5

6

7

8

9

10

11

Unemployment Rate

8. Refer to figure 36-5. Suppose the economy starts at 5% unemployment and 3% inflation and expected inflation remains at 3%. Which one of the following points could the economy move to in the short-run if the central bank pursues a more expansionary monetary policy? a. 7% unemployment and 1% inflation. b. 7% unemployment and 3% inflation. c. 3% unemployment and 5% inflation. d. 3% unemployment and 7% inflation. ANS: C PTS: 1 DIF: 3 REF: 36-2

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Chapter 36 /The Short-Run Trade-Off Between Inflation and Unemployment ❖ 9

9. If inflation expectations decline, then the short-run Phillips curve shifts a. left, so that at any inflation rate unemployment is lower in the short-run than before. b. right, so that at any inflation rate unemployment is lower in the short-run than before. c. right, so that at any inflation rate unemployment is higher in the short-run than before. d. left, so that at any inflation rate unemployment is higher in the short-run than before.

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10 ❖ Chapter 36 /The Short-Run Trade-Off Between Inflation and Unemployment

ANS: A

PTS: 1

DIF: 3

REF: 36-2

10. The equation, Unemployment rate = Natural rate of unemployment - a ctual inflation - Expected inflation), a. is the equation of the short-run Phillips curve. b. implies there can be no stable short-run Phillips curve. c. reflects the reasoning of Friedman and Phelps. d. All of the above are correct.

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Chapter 36 /The Short-Run Trade-Off Between Inflation and Unemployment ❖ 11

ANS: D

PTS: 1

DIF: 2

REF: 36-2

11. According to Friedman and Phelps, the unemployment rate a. is never below its natural rate. b. is below its natural rate when actual inflation is greater than expected inflation. c. is below its natural rate when actual inflation is less than expected inflation. d. is below its natural rate when actual inflation equals expected inflation.

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12 ❖ Chapter 36 /The Short-Run Trade-Off Between Inflation and Unemployment

ANS: B

PTS: 1

DIF: 2

REF: 36-2

12. If people eventually adjust their inflation expectations so that in the long-run actual and expected inflation are the same, then policymakers a. Cannot exploit a tradeoff between inflation and unemployment in either the short or long-run. b. Can exploit a tradeoff between inflation and unemployment in the short-run but not in the long-run. c. Can exploit a tradeoff between inflation and unemployment in both the short-run and the long-run. d. Can exploit a tradeoff between inflation and unemployment in the long-run, but not the short-run.

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Chapter 36 /The Short-Run Trade-Off Between Inflation and Unemployment ❖ 13

ANS: B

PTS: 1

DIF: 1

REF: 36-2

13. In the long-run, an increase in the money supply a. leaves prices and unemployment unchanged. b. raises prices and unemployment. c. raises prices and leaves unemployment unchanged. d. leaves prices unchanged and reduces unemployment.

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14 ❖ Chapter 36 /The Short-Run Trade-Off Between Inflation and Unemployment

ANS: C

PTS: 1

DIF: 1

REF: 36-2

14. In the long-run, a decrease in the money supply growth rate a. increases inflation and shifts the short-run Phillips curve right. b. increases inflation and shifts the short-run Phillips curve left. c. decreases inflation and shifts the short-run Philips curve right. d. decreases inflation and shifts the short-run Phillips curve left.

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Chapter 36 /The Short-Run Trade-Off Between Inflation and Unemployment ❖ 15

ANS: D

PTS: 1

DIF: 2

REF: 36-2

15. In the long-run a reduction in the money supply growth rate affects a. the inflation rate and the natural rate of unemployment. b. the inflation rate but not the natural rate of unemployment. c. neither the inflation rate nor the natural rate of unemployment. d. the natural rate of unemployment, but not the inflation rate.

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16 ❖ Chapter 36 /The Short-Run Trade-Off Between Inflation and Unemployment

ANS: B

PTS: 1

DIF: 2

REF: 36-2

16. In the nineteenth century, some countries were on a gold standard so that on average the money supply growth rate was close to zero and expected inflation was more or less constant. For these countries during this time period, we find that increases in actual inflation were generally associated with falling unemployment. These findings a. are consistent with Friedman and Phelps’s theories, because they argued that when inflation was higher than expected, unemployment would fall. b. are consistent with Friedman and Phelps's theories, because they argued that when prices rose unemployment would fall whether actual inflation was higher than expected or not. c. are inconsistent with Friedman and Phelps's theories, because they argued that higher inflation would increase unemployment. d. are inconsistent with Friedman and Phelps's theories, because they argued that inflation and unemployment are unrelated.

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Chapter 36 /The Short-Run Trade-Off Between Inflation and Unemployment ❖ 17

ANS: A

PTS: 1

DIF: 3

REF: 36-2

17. If a government redesigned its unemployment insurance programs so that the unemployed had greater incentives to quickly find appropriate jobs, then which of the following curves would shift right? a. The long-run Phillips curve and the long-run aggregate supply curve. b. The long-run Phillips curve but not the long-run aggregate supply curve. c. The long-run aggregate supply curve but not the long-run Phillips curve. d. Neither the long-run Phillips curve nor the long-run aggregate supply curve. ANS: C PTS: 1 DIF: 2 REF: 36-2 18. If people anticipate higher inflation, but inflation remains the same then a. the short-run Phillips curve would shift right and unemployment would rise. b. the short-run Phillips curve would shift right and unemployment would fall. c. the short-run Phillips curve would shift left and unemployment would rise. d. the short-run Phillips curve would shift left and unemployment would fall. ANS: A PTS: 1 DIF: 3 REF: 36-2 19. For many years country A has had a lower unemployment rate than country B. According to the long-run Phillips curv...