Answer to Question #153436 in Macroeconomics for serin yong chin wei

Question

1)     Assume the economy has a natural rate of unemployment of 5%. Graphically illustrate when the actual inflation is 4% and expected inflation is 2%. What will happen to the economy when expected inflation adjust to the actual inflation in the long-run?

Answer 1

According to Phillips curve, rate of unemployment and rate of inflation are inversely related. As inflation increases, unemployment decreases. Therefore, when inflation moves from 2% to 4%, the economy growth rate (unemployment) decreases significantly in the long-run.