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What is the key difference in the short and long-run relationship of inflation and unemployment?
In the short-run, there is a trade-off between inflation and unemployment. In the long-term, the unemployment rate becomes independent on inflation.
Why is the long-run Philips curve vertical?
In the long-run, unemployment rate equals the natural rate of unemployment. As such, unemployment is constant for every level of inflation.
How does expected inflation affect the unemployment?
Due to a difference in expectations to inflation, real wages change, which changes corporate profits. This leads to hiring more or laying off workers.
What can shift the short-run Phillips curve? At what point do people adjust it back to? Why?
Adjustment to higher or lower than expected inflation. It is adjusted back to the long-run Phillips curve in order to maintain their previous real wages.
What is the effect of adjustments to a different than expected inflation regarding unemployment in the long run? What does this imply?
Unemployment reverts back to the long-run Phillips curve. This implies that there is no relationship between inflation and unemployment in the long run because it will always revert back to the natural rate of unemployment.
What occurs when there is an expansionary or contractionary policy? What occurs after?
A movement up or down along the short-run curve. As inflation is different than expected, real wages will be readjusted. Hence, it will shift the curve back to equilibrium.
Why is a higher Phillips curve less favorable?
A higher one implies that a higher rate of inflation is needed to maintain the same rate of unemployment.
In the long-run what is the effect of monetary or fiscal policies?
It only affects inflation, but not unemployment.
What determines how quickly adjustments occur for inflation? Why is this?
At different levels of inflation. I.e.
1. Low
2. Moderate
3. High and unstable
The threat to not adjust increases with inflation. As such, the higher it is, the quicker people try to adjust.
Define: rational expectations
Forming expectations by using all available information about an economic variable
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