2159_0001 - 402 I FA RT Iv Business Cycle Theory: The...

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Unformatted text preview: 402 I FA RT Iv Business Cycle Theory: The Economy in the Short Run KEY CONCEPTS r mum-mm Sticky—price model Demand—pull inflation Natural—rate hypothesis Imperfectminformation model Cost—push inflation Hysteresis l Phillips curve Sacrifice ratio Adaptive expectations Rational expectations notations eon REWEW , Mm 1. Expiain the two theories of aggregate supply 4. Expiain the difierences between demand~pull On what market imperfection does each theo» inflation and cost—push inflation. ry rely? What do the theories have in 5. Under what circumstances might it be possible : ’ . . . . Common' to reduce inflation Without causmg a 2. How is the Phillips curve related to aggregate . recession? : . . . . . - Supply‘ 6. Explain two ways in which a recession might 3. Why might inflation be inertial? raise the natural rate of unemployment. PROBLEMS AND APPLICATEONS W 1. In the sticky—price model, describe the aggre— 3. According to the rational—expectations approach, gate supply curve in the following special if everyone believes that policymakers are com« cases. How do these cases compare to the mitted to reducing inflation, the cost of reducing short—run aggregate supply curve we discussed inflationkthe sacrifice ratio—mwill be lower than in Chapter 9? if the public is skeptical about the policymakers’ a. NO firms have flexible prices (5 = 1). intentions. Why might this be true? How might credibiiity be achieved? b. The desired price does not depend on aggre— ' _ _ _ gate output (a = 0)_ 4. Suppose. that the economy 15 initially at a long— run equilibrium. Then the Fed increases the money supply. 2. Suppose that an economy has the Phillips curve at : 7r_1— 0.504 — 0.06). a. What is the natural rate of unemployment? a. Assuming any resulting inflation to be unex— pected, explain any changes in GDP, b. Graph the short—run and long—run relationships unemployment, and inflation that are caused between inflation and unemployment. by the monetary expansion. Explain your C. HOW much Cyclical unemployment is neces_ conclusions using three diagrams: one for the Saw to reduce inflation by 5 percentage IS~LM model, one. for the ADwAS model, points? Using Okun’s law, compute the saCi-i— and one for the Phllhps curve" fice ratio. b. Assuming instead that any resulting inflation ‘ d. Inflation is running at 10 percent. The Fed is éxpected’ explain any Changes m GDP’ wants to reduce it to 5 percent. 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2159_0001 - 402 I FA RT Iv Business Cycle Theory: The...

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