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    Unemployment and inflation

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    An economy has an unemployment rate of 4 percent and an inflation rate of 5 percent a year at point A in the figure

    **figure attached**

    Some events occur that move the economy in a clockwise loop from A to B to D to C and back to A.

    A) Describe the events that could create this sequence.
    B) Draw in the figure the sequence of the economy's short-run and long-run Phillips curves.
    C) Has the economy experienced demand-pull inflation, cost-push inflation, expected inflation or none of the these?

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    Solution Preview

    The Phillips curve shows us a short term trade off between unemployment and inflation, given fixed costs of production and inflationary expectations. It works when changes in aggregate demand are the primary drivers of economic activity. The trade off is only valid in the short run; in the long run unemployment levels are dictated by the natural rate of ...

    Solution Summary

    How the phillips curve illustrates the relationship between unemployment and inflation