Question

INFLATION RATE (Percent)

9
1
Figure 35-4
LRPC
SAPC
SRPC₂
2 3 4 5 6 7 8 9 10
UNEMPLOYMENT RATE (Percent)
Refer to Figure 35-4. If the economy starts at 5% unemployment and 5% inflation then if the Federal Reserve pursues a contractionary monetary policy, in the short run the economy moves to
O a. 7% unemployment and 3% inflation. In the long run the economy moves to 5% unemployment and 3% inflation.
O b. 3% unemployment and 5% inflation. In the long run the economy moves to 5% unemployment and 3% inflation.
Oc7% unemployment and 3% inflation. In the long run the economy moves to 5% unemployment and 5% inflation.
O d. 3% unemployment and 5% inflation. In the long run the economy moves to 5% unemployment and 5% inflation.

Answer 1

In the short run, contractionary monetary policy leads to higher unemployment and lower inflation. In the long run, the economy moves towards its natural rate of unemployment, but inflation may still change.

In the short run, if the Federal Reserve pursues a contractionary monetary policy, the economy will experience a decrease in aggregate demand, leading to higher unemployment and lower inflation. Therefore, the correct answer is a. 7% unemployment and 3% inflation. This is because contractionary monetary policy usually involves increasing interest rates, which reduces borrowing and spending, causing a decrease in aggregate demand.

In the long run, the economy will eventually move back to its natural rate of unemployment, called the Non-Accelerating Inflation Rate of Unemployment (NAIRU), which is represented by the Long-Run Phillips Curve (LRPC). This means that in the long run, the economy will move towards its natural rate of unemployment, which is usually lower than the initially observed unemployment rate.

However, in the long run, the economy can experience changes in inflation due to the influence of various factors, such as changes in productivity, technology, or government policies.