AP Economics:
Phillips Curve FRQs
March 27, 2015
Phillips Curve FRQs
1. Assume that the economy of Hopeton is currently in long-run equilibrium, with a
natural rate of unemployment equal to 5 percent and an inflation rate of 2 percent.
(a) Draw a correctly labeled graph of the short-run Phillips curve, and label the
curve as “SRPC.” Indicate the point on the SRPC corresponding to the current
unemployment and inflation rates, labeled as “R”.
Correctly labeled axes; Intersection of LRPC and SRPC curves labeled R and at 2% inflation
and 5% UR
(b) On your graph in part (a), draw the long-run Phillips curve, and label it as
“LRPC.” Vertical at 5%
(c) Assume that the government of Hopeton increases spending to finance repairs
and maintenance of the country’s infrastructure. How will such an increase in
spending affect unemployment and inflation in the short-run? Explain. The
increase in G shifts AD curve to the right, raising both Real GDP and Price
Levels. This leads to decrease in unemployment and increase in inflation.
(d) Show on your graph in part (a) the new point on the SRPC corresponding to the
results that you stated in part (c), labeled as “S.” See graph
(e) Following an increase in government spending, workers demand and receive a
higher wage. What happens to the SRPC as a result of the higher wage?
Explain. SPRC shifts up (right). With each level of unemployment, inflation
will be higher.
2. Assume that the United States economy is in long-run equilibrium with an expected
inflation rate of 6 percent and an unemployment rate of 5 percent. The nominal interest rate
is 8 percent.
(a) Using a correctly labeled graph with both the short-run and long-run Phillips
curves and the relevant numbers from above, show the current long-run
equilibrium as point A.
Correct labels, point A intersection labeled 6% and 5%
(b) Calculate the real interest rate in the long-run equilibrium. 8%-6%=2%
(c) Assume now that the Federal Reserve decides to target an inflation rate of 3
percent. What open-market operation should the Federal Reserve undertake?
Sell securities
(d) Using a correctly labeled graph of the money market, show how the Federal
Reserve’s action you identified in part (c) will affect the nominal interest rate.
Correct labels, MS shifts left, r increases
(e) How will the interest rate change you identified in part (d) affect aggregate
demand in the short run? Explain. AD decreases. Increase in r causes decrease in C,
a component of AD.
(f) Assume that the Federal Reserve action is successful. What will happen to each of
the following as the economy approaches a new long-run equilibrium?
(i) The short-run Phillips curve. Explain. SRPC shifts left because inflation
expectations decrease.
(ii) The natural rate of unemployment unchanged
3. The unemployment rate is an important indicator of the health of the United States
economy.
(a) Assume that with the economy at full employment, the government implements
an expansionary fiscal policy. How does the actual unemployment rate at the
new short-run equilibrium compare with the natural rate of unemployment?
UR will be below natural rate in short run
(b) Assume that a significant number of workers are involuntarily changed from
full-time to part-time employment. Explain how this will affect the number of
people who are officially classified as unemployed. No change – part time
workers are counted as employed
(c) Assume that the government reduces the level of unemployment compensation.
(i) Explain how this affects the natural rate of unemployment. UR may fall as
labor force expands because more persons will seek work after their UI
benefits are reduced.
(ii) Using a correctly labeled graph, show how this affects the long-run Phillips
curve.
Correct labels, LRPC shifts left
4. The unemployment rate in the country of Southland is greater than the natural rate of
unemployment.
(a) Using a correctly labeled graph of aggregate demand and aggregate supply,
show the current equilibrium real gross domestic product, labeled YC, and price
level in Southland, labeled PLC.
Correct labels, downward sloping AD, upward sloping SRAS, vertical LRAS to the right of
intersection of SRAS and AD
The President of Southland is receiving advice from two economic advisers—Kohelis and
Raymond—about how best to reduce unemployment in Southland.
(b) Kohelis advises the President to decrease personal income taxes.
(i) How would such a decrease in taxes affect aggregate demand? Explain. AD
shifts to right. Decrease in taxes raises disposable income, raising C, a
component of AD.
(ii) Using a correctly labeled graph of the short-run Phillips curve, show the
effect of the decrease in taxes. Label the initial equilibrium from part (a) as
point A, and the new equilibrium resulting from the decrease in taxes as
point B.
Correct labels, downward sloping SRPC, point B at higher inflation rate than point A due to
increase in AD.
(c) Raymond advises the President to take no policy action.
(i) What will happen to the short-run aggregate supply curve in the long run?
Explain. SRAS will shift to the right. Wages will eventually fall, reducing
costs to firms, who then increase production.
(ii) Using a new correctly labeled graph of the short-run Phillips curve, show the
effect of the change in the short-run aggregate supply you identified in
part (c)(i).
Correct labels, SRPC shifts downward