Question

We wrote the Phillips Curve equation in lecture in such a way that it demonstrates inertia. In other words, increasing inputs by ×% will increase output by exactly ×% changing a nominal variable (like prices) won't change real variables (like output) without supply shocks or cyclical unemployment, inflation will continue at its current rate only shifts of the AS curve can cause ouput to change Consider an economy with a current inflation rate of 6 percent; they would prefer it be 3 percent instead. Using our setup from the lecture, this economy would have to sacrifice of one year's real GDP to get inflation where they'd like. percent

Answer 1

If the economy wants to reduce inflation from 6% to 3%, it would need to shift the aggregate supply (AS) curve to the right. This means that the economy would have to increase its output without increasing prices.

However, according to the Phillips Curve equation, changes in nominal variables (like prices) do not affect real variables (like output) in the absence of supply shocks or cyclical unemployment. This means that the economy would have to increase its output without increasing prices, which is difficult to achieve.

Assuming that the economy is operating at full employment, the only way to shift the AS curve to the right is to increase the economy's productivity. This would require investment in capital and technology, which would take time and resources.

Therefore, it is difficult for the economy to reduce inflation from 6% to 3% without sacrificing some of its output in the short run. The amount of output that the economy would have to sacrifice would depend on the specific circumstances of the economy and the policies implemented to shift the AS curve to the right.