- Based on the Phillips Curve shown, the economy moves from point A to point B following a negative supply shock (such as a large increase in oil prices). In the short run, which outcome is illustrated?
Answer: Inflation rises and unemployment rises because the short-run Phillips Curve shifts right.
The Phillips Curve demonstrates the short-run tradeoff between inflation and unemployment, but supply shocks create a different pattern. A negative supply shock like rising oil prices increases production costs, shifting the SRPC rightward from point A to point B. This creates stagflation—both higher inflation and higher unemployment simultaneously, breaking the usual inverse relationship. Students often assume all economic changes involve tradeoffs, but supply shocks worsen both variables. To identify supply shock effects on the Phillips Curve, look for movements where both inflation and unemployment increase (negative shock) or decrease (positive shock) together.
- Based on the Phillips Curves shown, SRPC1 intersects the long-run Phillips Curve (LRPC) at point A. Suppose the government increases spending, raising aggregate demand so the economy moves to point B on SRPC1. In the long run, if inflation expectations adjust, which change is most consistent with the model?
Answer: The short-run Phillips Curve shifts right until unemployment returns to the natural rate on the LRPC.
The Phillips Curve model shows that while short-run tradeoffs exist between inflation and unemployment, the long-run Phillips Curve is vertical at the natural rate. Starting at the LRPC intersection (point A), increased government spending raises aggregate demand, moving the economy to point B with lower unemployment and higher inflation. However, this position is unsustainable—as workers and firms adjust expectations to the higher inflation, the SRPC shifts rightward from SRPC₁ toward SRPC₂. This process continues until the new SRPC intersects the LRPC, returning unemployment to its natural rate but at permanently higher inflation. The key insight: fiscal expansion can temporarily reduce unemployment but only permanently raises inflation in the long run.
- Based on the short-run Phillips Curve shown, the economy moves from point A to point B due to a decrease in aggregate demand. Which change is illustrated in the short run?
Answer: Inflation decreases and unemployment increases as the economy moves along the short-run Phillips Curve.
The Phillips Curve shows an inverse relationship between inflation and unemployment in the short run, represented by the downward-sloping SRPC. When aggregate demand decreases, the economy moves down and to the right along the existing SRPC from point A to point B. This movement shows falling inflation (as reduced demand lowers price pressures) and rising unemployment (as firms lay off workers due to lower sales). A common error is thinking demand changes shift the curve, but they cause movements along it. To analyze Phillips Curve questions correctly, distinguish between movements along curves (demand changes) and shifts of curves (supply shocks or expectation changes).
- Based on the Phillips Curve shown, the long-run Phillips Curve (LRPC) is vertical at un=5%. If the economy is currently at point B with unemployment below un, then after wages and prices fully adjust, which outcome is most consistent with the long run?
Answer: Unemployment returns to 5% and inflation rises relative to the initial long-run equilibrium.
The Phillips Curve model features a vertical long-run Phillips Curve (LRPC) at the natural unemployment rate, indicating no permanent inflation-unemployment tradeoff. When the economy is at point B with unemployment below 5% (the natural rate), it cannot sustain this position indefinitely. As workers realize inflation is higher than expected, they demand wage increases, shifting the SRPC rightward until the economy reaches a new equilibrium on the LRPC at 5% unemployment. The final inflation rate will be higher than initially because expectations have adjusted upward. The misconception of a permanent tradeoff ignores that the LRPC is vertical—in the long run, unemployment always returns to its natural rate. - Based on the short-run Phillips Curve shown, the economy moves from point A to point B. The central bank states that the change was caused by contractionary monetary policy that reduced aggregate demand. In the short run, which interpretation matches the movement shown?
Answer: Inflation decreases and unemployment increases as the economy moves along the short-run Phillips Curve.
The Phillips Curve demonstrates the short-run inverse relationship between inflation and unemployment, with monetary policy affecting aggregate demand. Contractionary monetary policy reduces aggregate demand by raising interest rates, decreasing investment and consumption. This causes the economy to move down and to the right along the SRPC from point A to point B, resulting in lower inflation (reduced demand pressure) and higher unemployment (firms reduce output and employment). A common misconception is thinking monetary policy shifts the Phillips Curve, but it causes movement along the existing curve. Remember: monetary and fiscal policies that change aggregate demand cause movements along the SRPC, not shifts of it.
- Based on the short-run Phillips Curves shown, the economy is at point A on SRPC1. A favorable supply shock (such as a sustained decrease in input costs) occurs with inflation expectations unchanged. In the short run, which change is illustrated?
Answer: The short-run Phillips Curve shifts left, lowering inflation at each unemployment rate.
The Phillips Curve framework distinguishes between movements along curves and shifts of curves, with the SRPC showing the inflation-unemployment tradeoff. A favorable supply shock, like lower input costs, reduces production expenses across the economy, shifting the entire SRPC leftward from SRPC₁ to SRPC₂. This shift means lower inflation at each unemployment level, as firms can maintain output with lower prices. Students often confuse supply shocks with demand changes, but supply shocks shift the curve while demand changes cause movement along it. Remember: favorable supply shocks shift SRPC left (improving both variables), while adverse shocks shift it right (worsening both).
- Based on the short-run Phillips Curve shown, the economy moves from point A to point B after an increase in aggregate demand. Which of the following best describes the change in inflation and unemployment in the short run?
Answer: Inflation increases and unemployment decreases as the economy moves along the short-run Phillips Curve.
The Phillips Curve shows the inverse relationship between inflation and unemployment in the short run. When aggregate demand increases, the economy moves up and to the left along the short-run Phillips Curve (SRPC), from point A to point B. This movement represents higher inflation and lower unemployment, as increased demand pushes prices up while firms hire more workers to meet demand. A common misconception is thinking this tradeoff is permanent, but it only exists in the short run before expectations adjust. To analyze Phillips Curve movements, always check whether you're moving along a curve (demand changes) or shifting the curve (supply shocks or expectation changes).
