Review Questions – AD/AS models, Phillips Curve, expectations
(1) Use the IS/LM framework to explain why the aggregate demand curve is downward sloping
(2). In the sticky-price model, describe the aggregate supply curve in the following special cases. How do these cases compare to the short-run aggregate supply curve we discussed in Chapter 10?
1. All firms have sticky prices (s = 1).
2. The desired price does not depend on aggregate output (a = 0).
(3). Suppose that an economy has the Phillips curve
π = π−1 − 0.5(u − 5).
1. What is the natural rate of unemployment?
2. Graph the short-run and long-run relationships between inflation and unemployment.
3. How much cyclical unemployment is necessary to reduce inflation by 4 percentage points? Using Okun’s law, compute the sacrifice ratio.
4. Inflation is running at 6 percent. The central bank wants to reduce it to 2 percent. Give two scenarios that will achieve that goal.
(4) for the following aggregate demand and aggregate supply curves,
Case 1
Qd = 100/P
Qs = 10
Case 2
Qd = 10
Qs = (P + 110)1/2
1. Contrast and algebraically discuss the equilibrium level of prices (and thereby output and employment) in the two cases above
2. Which demand curve shows money illusion
3. Which supply curve is classical and which is Keynesian? Why?
(5) compare and contrast the perfect foresight, adaptive expectation, and rational expectation approach to forming expectations.