Reference no: EM131112419

An economy has the following eqn for the Phillips Curve: pi=Epi - .5(u-6) People form expectations of inflation by taking a weighted average of the previous 2 years of inflation: Epi=0.7pi-1 + 0.3pi-2 Okun's law for this economy is: (Y-Y1)/Y-1 = 3.0-2.0 (u-u-1) The economy begins at its natural rate of unemployment with a stable inflation rate of 5 percent. (A) what is the natural rate of unemployment for this economy? (B) Graph the short-run tradeoff between inflation and unemployment that this economy faces. Label the point where the economy begins as point A (C) A fall in aggregate demand leads to a recession, causing the unemployment rate to rise 4 percentage points above its natural rate. On your graph in part (A) label the point the economy experiences that year as point B. (D) Unemployment remains at this high level for two years (the initial year described in point (C) and one more), after which it returns to its natural rate. Create a table showing unemployment, inflation, expected inflation, and output growth for 10 years beginning 2 years after the recession. (E) on the same graph in part (B), graph the SR tradeoff the economy faces at the end of this 10-yr period. Label the point where the economy finds itself as point C. (F) Compare the equilibrium before the recession with the new long-run equilibrium. How much does inflation change? How many percentage points of output are lost during the transition? What is this economy's sacrifice ratio?