Answer the questions below on the basis of the following data.
Actual
Expected
inflation
inflation
Point A:2%
2%
Point B:4%
4%
Point C:2%
4%
Point D:4%
2%
a.Suppose the equation describing the Phillips curve is ? = ?e? 2(U? 5). For each of the points: A, B, C, and D, calculate the unemployment rate. b.Based on the equation in part a, what is the numerical value of the natural rate of unemployment?
What will be an ideal response?
| a. | Standard figure, similar to text figure. Draw it so that points D and B are at the same actual inflation rate of 4 percent and points A and C are at the same actual inflation rate of 2 percent. Points A and D are on the same short-run Phillips curve, with an expected inflation rate of 2 percent. Points B and C are on the same short-run Phillips curve, with an expected inflation rate of 4 percent. |
| b. | Point A: ? = ?e? 2(U? 5) |
| 2 = 2 ? 2(U? 5), so 2(U? 5) = 0, so U? 5 = 0, so U = 5%. | |
| Point B: 4 = 4 ? 2(U? 5), so 2(U? 5) = 0, so U? 5 = 0, so U = 5%. | |
| Point C: 2 = 4 ? 2(U? 5), so 2(U? 5) = 2, so U? 5 = 1, so U = 6%. | |
| Point D: 4 = 2 ? 2(U? 5), so 2(U? 5) = ?2, so U? 5 = ?1, so U = 4%. | |
| c. | The natural rate of unemployment is 5 percent, from the term in parentheses in the equation. |
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