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1. Aggregate demand, aggregate supply, and the Phillips curve

In the year 2020, aggregate demand and aggregate supply in the fictional country of Gizmet are represented by the curves and AS on the

following graph. The price level is 102. The graph also shows two possible outcomes for 2021. The first potential aggregate demand curve is given by

the curve, resulting in the outcome illustrated by point A. The second potential aggregate demand curve is given by the curve, resulting in

the outcome illustrated by point B.

108

107

AS
106

105
A
104
AD2020
103 AD
B

102 ADA

101

100
0 2 4 6 8 10 12 14 16

Suppose the unemployment rate is 7% under one of these two outcomes and 5% under the other. Based on the previous graph, you would

expect outcome B to be associated with the lower unemployment rate (5%).

Points: 1/1

Explanation: Close Explanation

Producing more output requires hiring more workers. Since more output is produced at outcome B than at outcome A, unemployment is almost
certainly lower if the economy is at outcome B.

If aggregate demand is high in 2021, and the economy is at outcome B, the inflation rate between 2020 and 2021 is 2.94% .

Points:

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Explanation: Close Explanation

The price level at outcome B is 105. Since the price level in 2020 was 102, this represents a 2.94% rise in the price level between 2020 and
2021:

Based on your answers to the previous questions, on the following graph use the purple point (diamond symbol) to plot the unemployment rate and
inflation rate if the economy is at point A. Next, use the green point (triangle symbol) to plot the unemployment rate and inflation rate if the economy

is at point B. (As you place these points, dashed drop lines will automatically extend to both axes.) Finally, use the black line (cross symbol) to draw
the short-run Phillips curve for this economy in 2021.

Hint: Hover your cursor over each point after you plot it to make sure you have placed it on the exact coordinate you intended.

Correct Answer Your Answer

7
Outcome A

3 Phillips Curve

0
0 1 2 3 4 5 6 7 8

Points: 0/1

Explanation: Close Explanation

You found before that the inflation rate at outcome B was 2.94%. You also determined that of the two unemployment rates given (5% and 7%),

the unemployment rate at outcome B was 5%. Therefore, the point for outcome B has the coordinates (5, 2.94). The coordinates for outcome A
are determined in the same way.

The short-run Phillips curve, which shows the short-term relationship between inflation and unemployment, passes through these two points.

Suppose that the government is considering enacting an expansionary policy in 2020 that would shift aggregate demand in 2021 from to .

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This would cause a movement along the short-run Phillips curve, resulting in an increase in the inflation rate and a decrease in the

unemployment rate.

Points: 0/1

Explanation: Close Explanation

The effect of this policy would be to shift the economy from outcome A to outcome B. Since the short-run Phillips curve passes through the
inflation/unemployment combinations that correspond to points A and B, this would cause a movement along the short-run Phillips curve from
the point you plotted in purple on the previous graph to the point you plotted in green.

This illustrates why the government faces a short-run tradeoff between unemployment and inflation. If it pursues an expansionary policy, output

increases and unemployment falls, but inflation rises. On the other hand, if it tries to control inflation through a contractionary policy, output
decreases and unemployment rises.

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