Numerical Problems

1.

Sincethenaturalrateofunemploymentis0.06, e2(u0.06),sou0.060.5( e),or

u0.060.5( e).
(a) Year1:u0.060.5(0.080.04)0.060.020.08.Theunemploymentrateis0.02higher
thanthenaturalrate.Thepercentagethatoutputfallsshortoffullemploymentoutputis
20.020.04,or4%.
Year2:u0.060.5(0.040.04)0.06.Theunemploymentrateequalsthenaturalrate,since
inflationequalsexpectedinflation.Sinceunemploymentisatitsnaturalrate,outputisatits
fullemploymentlevel.
Sincetheoutputlosswas4percentagepointsandinflationdeclinedby8percentagepoints,the
sacrificeratiois4/80.5.
(b) Useequations:u0.060.5( e),outputshortfall2(u0.06).
Year
1
2
3
4

u0.06

OutputShortfall

0.08
0.04
0.04
0.04

0.10
0.08
0.06
0.04

0.07
0.08
0.07
0.06

0.01
0.02
0.01
0.0

0.02
0.04
0.02
0.0

Thetotaloutputshortfallis0.020.040.020.00.088percentagepointsofoutputlost.
Inflationfellby8percentagepoints.Sothesacrificeratiois8/81.Noticethat,comparedwith
parta,thesacrificeratioishigher,forthisslowerdisinflation.
2.

(a) Equatingaggregatedemandtoshortrunaggregatesupplygives:30010(M/P)500PPe,
or300(101000/P)500P50,or10,000/P150P.Multiplyingbothsidesofthe
equationbyPandrearranginggivesP2150P10,0000,whichcanbefactoredas(P50)
(P200)0.ThishasthenonnegativesolutionP50.SincePeisalso50,theexpectedprice
levelequalstheactualpricelevel,sooutputisatitsfullemploymentlevelof500andthe
unemploymentrateisatthenaturalrateof6%.Thesearethelongrunequilibriumvaluesofthe
threevariablesaswell.
(b) Whenthenominalmoneysupplyincreasesunexpectedlyto1260,weagainequateaggregate
demandtoshortrunaggregatesupply,whichgives:30010(M/P)500PPe,or300
(101260/P)500P50,or12,600/P150P.Multiplyingbothsidesoftheequationby
PandrearranginggivesP2150P12,6000,whichcanbefactoredas(P60)(P210)0.
ThishasthenonnegativesolutionP60.WhenP60,theshortrunaggregatesupplycurve
givesY500PPe5006050510.Outputof510is2%abovefullemployment
outputof500,because(510500)/5000.02.Withanaturalunemploymentrateof0.06,
OkunsLawgives0.022(u0.06).Thiscanbesolvedtogetu0.05.
Inthelongrun,PeadjuststoequalP,outputadjuststoitsfullemploymentlevelof500,and
unemploymentadjuststothenaturalrateof0.06.TofindP,usetheaggregatedemandcurve
toget50030010(1260/P),or20012,600/P,whichcanbesolvedtogetP63.
Theresultsofthisexerciseareconsistentwiththeexistenceofanexpectationsaugmented
Phillipscurve.Unexpectedinflationreducesunemploymentintheshortrun.Inthelongrun,
however,inflationishigherandunemploymentreturnstoitsnaturalrate.

3.

(a) 0.102(u0.06)0.222u.ThisisshownasthePhillipscurvelabeledPCainFigure
12.6.IftheFedkeepsinflationat0.10,thenu0.06,thenaturalrateofunemployment.

Figure12.6
(b) Withexpectedinflationrisingto12%,thePhillipscurveis 0.122(u0.06)0.242u.
ThisisthePhillipscurvelabeledPC binthefigure.Thehigherrateofexpectedinflationhas
causedthecurvetoshiftuprelativetowhereitwasinpart(a).Withtheactualinflationrateat
10%,thePhillipscurveequationis0.100.122(u0.06),whichhasthesolutionu0.07.So
iftheFedtriestomaintaintheexistingrateofinflationafterashockhasraisedinflation
expectations,theunemploymentrateincreases.However,iftheFedcouldconvincepeoplethat
theinflationratereallywouldnotrise,sothat eremainsat0.10,thentheshortrunPhillips
curvewouldremainatPC a,andtheunemploymentratewouldnotincrease.
(c) Withthenaturalrateofunemploymentrisingto0.08atthesametimethatexpectedinflation
risesto0.12,thePhillipscurveequationis0.122(u0.08)0.282u.ThisisthePhillips
curvelabeledPC cinthefigure.ThenewshortrunPhillipscurveisevenhigherthanthosefor
parts(a)and(b).Withtheactualinflationrateheldto10%,theequationbecomes0.100.28
2u,whichcanbesolvedtogetu0.09.TheunemploymentraterisesbothbecausetheFed
holdsinflationbelowexpectedinflationandbecausethenaturalratehasincreased.
Thistime,eveniftheFedconvincedpeoplethatinflationwouldremainjust10%,the
unemploymentratewouldstillriseto8%,sincethenaturalratehasincreasedtothatlevel.
4.

(a) Beginninginlongrunequilibrium,withM4000,outputmustbeatitsfullemploymentlevel
of6000andtheunemploymentratemustbeequaltothenaturalrateof.05.Usingthevaluesfor
YandMintheADcurve,600040002(4000/P),whichgivesP4.Thisisalsotheexpected
pricelevel.BecauseMhasbeenconstantforalongtimeandisexpectedtoremainconstant,
e0.

(b) WithP e4,theSRAScurveisY6000100(P4).TheADcurveisY40002(4488/P).

Theintersectionofthetwocurvesoccurswhen6000100(P4)40002(4488/P).
Simplifyingtermsgives100P21600P89760,whichhasthesolutionP4.4.Plugging
thisintotheSRAScurvegivesY6040.FromtheOkunsLawequationweget(6040
6000)/60002(u.05),so0.00333u.05,sou.0467.Cyclicalunemploymentisu
u
.0033.Unanticipatedinflationis(PPe)/Pe.1010%.
u
e
(c) ThePhillipscurveequationis h(u ),whichgives.100h(.0467.05).Thisis
solvedtogeth30.SotheslopeofthePhillipscurveis30.