Question

Refer to Exhibit 16.6, which reflects the relationship between the inflation rate and the unemployment rate. If the economy started near point b and government purchases increased, we would expect the economy in the short run to move to _____

Answer 1

If the economy starts near point b on the Phillips Curve and the government increases purchases, in the short run we would expect to move toward lower unemployment and higher inflation, due to the rightward shift in AD resulting from the increase in government spending.

Step-by-step explanation:

The question refers to the Keynesian Phillips Curve, which describes a short-run tradeoff between unemployment and inflation. If the economy begins near point b, characterized by a 2% inflation rate and 7% unemployment, and the government increases its purchases, we would expect, according to Keynesian economics, a movement towards lower unemployment and higher inflation in the short run. This is because increased government spending would shift the aggregate demand (AD) curve to the right, temporarily boosting economic activity and reducing unemployment, but at the cost of increased inflation.

This is described in a scenario where an attempt to maintain an unemployment rate significantly below the natural rate, through expansionary fiscal policy, leads to higher inflation. As such, the short-run result of the government's increased purchases is the economy moving from point B towards a point closer to point A on the Phillips Curve, following the described pattern of lower unemployment and rising inflation.

Answer 2

Answer: Point C

Step-by-step explanation:

When government purchases increases, there will be more money in the economy which will have a multiplier effect in the economy of increasing investment and consumption spending both of which will lead to new companies being founded and old companies increasing capacity.

The unemployment rate will therefore decrease as more people are hired to boost capacity but the inflation rate will increase because of the rise in demand. The only point on the graph that shows these two things in point c so that is where the economy will move to in the short run.