Question

if the central bank keeps the money supply growth rate constant, but people raise their inflation expectations by 1 percentage point, then the short-run phillips curve shifts

Answer 1

The short-run Phillips curve shifts to the left when people increase their inflation expectations by 1 percentage point, leading to higher nominal wages without a change in real GDP, but an increase in the price level.

Step-by-step explanation:

If the central bank keeps the money supply growth rate constant, but individuals increase their inflation expectations by 1 percentage point, then the short-run Phillips curve shifts to the left. According to economic theories, an increase in inflation expectations leads to workers demanding higher wages, as they anticipate that the cost of living will rise. Employers, expecting that they will receive higher prices for their goods and services, are likely to acquiesce to these wage demands. This can lead to higher nominal wages without a corresponding increase in productivity, causing the short-run aggregate supply curve to shift. The immediate result in the short run is a movement along the long-run aggregate supply curve, illustrating no real change in GDP but an increase in the price level. The rise in inflation expectations effectively causes the tradeoff between inflation and unemployment, represented by the Phillips curve, to vanish, thereby causing the curve to shift.

Answer 2

The correct answer is option C. that the short-run Phillips curve shifts to the right, and the unemployment rate rises.

How did we arrive at this assertion?

The logic behind this assertion is explained thus;

1. Phillips Curve Relationship: The Phillips curve depicts an inverse relationship between inflation and unemployment in the short run. That is, lower unemployment tends to be associated with higher inflation and vice versa.

2. Inflation Expectations: When people raise their inflation expectations, they anticipate that prices will rise at a faster rate in the future.

Considering the given scenario, that is if people expect a higher rate of inflation, they will demand higher wages to compensate for the anticipated increase in prices.

3. Wage Demands and Unemployment: As workers demand higher wages, firms may be less willing to hire or may even reduce their workforce to control costs. This can result in higher unemployment.

4. Shift in the Phillips Curve: The Phillips curve, which shows the trade-off between inflation and unemployment, shifts to the right. This indicates that, at any given level of inflation expectations, the economy will experience a higher level of unemployment compared to the previous situation with lower inflation expectations.

Therefore, the correct answer is that the short-run Phillips curve shifts to the right, and the unemployment rate rises.

Complete question:

If the central bank keeps the money supply growth rate constant, but people raise their inflation expectations by 1 percentage point, then the short-run Phillips curve shifts

A. left and the unemployment rate falls.

B. right and the unemployment rate falls.

C. right and the unemployment rate rises.

D. left and the unemployment rate rises.