Chapter 27
The Phillips Curve and Expectations Theory
1. The Phillips curve relates the inflation rate to
a. the unemployment rate.
b. GDP.
c. disposable personal income.
d. the interest rate.
ANS
a. Correct. The Phillips curve relates the inflation rate to the unemployment rate.
b. Incorrect. The Phillips curve relates the inflation rate to the unemployment rate.
c. Incorrect. The Phillips curve relates the inflation rate to the unemployment rate.
d. Incorrect. The Phillips curve relates the inflation rate to the unemployment rate.
2. On a Phillips curve diagram, an increase in the rate of inflation, other things being
equal, is represented by a (an)
a. upward movement along the Phillips curve.
b. downward movement along the Phillips curve.
c. upward shift of the Phillips curve.
d. downward shift of the Phillips curve.
ANS
a. Correct. On a Phillips curve diagram, an increase in the rate of inflation, other things
being equal, is represented by an upward movement along the Phillips curve.
b. Incorrect. On a Phillips curve diagram, an increase in the rate of inflation, other things
being equal, is represented by an upward movement along the Phillips curve.
c. Incorrect. An increase in the rate of inflation does not shift the Phillips curve.
d. Incorrect. An increase in the rate of inflation does not shift the Phillips curve.
3. Economists began to lose confidence in the Phillips curve during the
a. 1930s.
b. 1960s.
c. 1970s.
d. 1980s.
ANS
a. Incorrect. Economists began to lose confidence in the Phillips curve during the
1970s.
b. Incorrect. Economists began to lose confidence in the Phillips curve during the
1970s.
c. Correct. During the 1970s, the U.S. economy experienced stagflation.
d. Incorrect. Economists began to lose confidence in the Phillips curve during the
1970s.
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4. The Phillips curve
a. was relatively well-defined during the 1960s.
b. demonstrates how to achieve stable economic growth.
c. shows the trade-off between deficits and inflation.
d. helps to stimulate entrepreneurial profits.
ANS
a. Correct. The Phillips curve was relatively well-defined during the 1960s.
b. Incorrect. The Phillips curve does not explain economic growth.
c. Incorrect. The Phillips curve does not show this tradeoff.
d. Incorrect. The Phillips curve does not explain profits.
5. If the long-run Phillips curve is vertical, then any government policy designed to lower
a. unemployment will not change the unemployment rate and only increase the inflation
rate.
b. unemployment will work leaving the inflation rate unchanged.
c. inflation will cause employment to rise.
d. unemployment will work causing the inflation rate to fall.
ANS
a. Correct. If the long-run Phillips curve is vertical, then any government policy designed
to lower unemployment will not change the unemployment rate and only increase the
inflation rate.
b. Incorrect. If the long-run Phillips curve is vertical, then any government policy
designed to lower unemployment will not change the unemployment rate and only
increase the inflation rate.
c. Incorrect. If the long-run Phillips curve is vertical, then any government policy
designed to lower unemployment will not change the unemployment rate and only
increase the inflation rate.
d. Incorrect. If the long-run Phillips curve is vertical, then any government policy
designed to lower unemployment will not change the unemployment rate and only
increase the inflation rate.
6. The natural rate hypothesis argues that the economy will
a. self-correct to the natural rate of inflation.
b. require expansionary fiscal policy to reach the natural rate of unemployment.
c. self-correct to the natural rate of unemployment.
d. require expansionary monetary policy to reach the natural rate of unemployment.
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ANS
a. Incorrect. This is a meaningless answer.
b. Incorrect. This hypothesis is based on self-correction.
c. Correct. The natural rate hypothesis argues that the economy will self-correct to the
natural rate of unemployment.
d. Incorrect. The natural rate hypothesis argues that the economy will self-correct to the
natural rate of unemployment.
7. The long-run Phillips curve is a (an)
a. horizontal
b. vertical
c. upward-sloping
d. downward-sloping
line at the natural rate of unemployment.
ANS
a. Incorrect. The long-run Phillips curve is a vertical line at the natural rate of
unemployment.
b. Correct. The long-run Phillips curve is a vertical line at the natural rate of
unemployment.
c. Incorrect. The long-run Phillips curve is a vertical line at the natural rate of
unemployment.
d. Incorrect. The long-run Phillips curve is a vertical line at the natural rate of
unemployment.
8. Under the natural rate hypothesis, expansionary monetary and fiscal policies can at
best produce a (an)
a. permanent change in the long-run Phillips curve.
b. short-run change in the unemployment rate.
c. long-run change in the unemployment rate.
d. permanent change in the unemployment rate.
ANS
a. Incorrect. Under the natural rate hypothesis, expansionary monetary and fiscal policies
can at best produce a short-run change in the unemployment rate.
b. Correct. Under the natural rate hypothesis, expansionary monetary and fiscal policies
can at best produce a short-run change in the unemployment rate.
c. Incorrect. Under the natural rate hypothesis, expansionary monetary and fiscal policies
can at best produce a short-run change in the unemployment rate.
d. Incorrect. Under the natural rate hypothesis, expansionary monetary and fiscal policies
can at best produce a short-run change in the unemployment rate.
9. The hypothesis that people believe the best indicator of the future is the recent past is
a. rational expectations.
b. adaptive expectations.
c. lagged expectations.
d. trend expectations.
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ANS
a. Incorrect. The hypothesis that people believe the best indicator of the future in the
recent past is known as adaptive expectations.
b. Correct. The hypothesis that people believe the best indicator of the future in the recent
past is known as adaptive expectations.
c. Incorrect. This is a meaningless term.
d. Incorrect. This is a meaningless term.
10. Under adaptive expectations theory, people expect the rate of inflation this year to be
a. zero, regardless of the rate last year.
b. the same as last year.
c. the rate based on predictable and fiscal policies.
d. All of the above answers are correct.
ANS
a. Incorrect. Under adaptive expectations, people believe the best indicator of the future is
recent information-the same as last year.
b. Correct. Under adaptive expectations, people believe the best indicator of the future is
recent information.
c. Incorrect. Under adaptive expectations, people believe the best indicator of the future is
recent information.
d. Incorrect. Only answer b. is correct.
11. According to adaptive expectations theory, expansionary monetary and fiscal policies
to reduce the unemployment rate are
a. useless in the long run.
b. useless in the short run.
c. ineffective on the price level.
d. None of the answers are correct.
ANS
a. Correct. In the long run, the unemployment rate remains unchanged at the natural rate.
b. Incorrect. Expansionary policy can reduce unemployment in the short run.
c. Incorrect. Expansionary policy increases the inflation rate.
d. Incorrect. Answer a. is correct.
12. "Preannounced, stable policies to achieve a low and constant money supply growth
and a balanced federal budget are therefore the best way to lower the inflation rate." This
statement best illustrates
a. Keynesian theory.
b. rational expectations theory.
c. incomes policy.
d. supply-side theory.
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ANS
a. Incorrect. Keynesians argue that prices and wages are “sticky” downward.
b. Correct. If workers are not surprised, they reduce their nominal wages as prices fall.
c. Incorrect. Incomes policy does not concern preannounced stable policy.
d. Incorrect. Supply-side theory does not concern preannounced stable policies.
Exhibit 10 Short-run and long-run Phillips curves
Long-run
Phillips curve
Inflation Rate
(percent)
5.0
A
4.5
B
E1
4.0
3.5
3.0
0
Short-run
Phillips
D curve
C
Natural rate
4.0
4.5 5.0
5.5
6.0
10
Unemployment Rate (percent)
13. Suppose the economy in Exhibit 10 is at point E1, and the Fed increases the money
supply. If people have adaptive expectations, then the economy will move
a. to point A in the short run and point B in the long run.
b. directly to point B.
c. to point C in the short run and point D in the long run.
d. directly to point D.
ANS
a. Correct. The increase in the money supply increases aggregate demand and causes the
move to point A where real wages fall, profits rise, and more workers hired. At point B in
long run, nominal wages rise, profits fall and the result is point
b. Incorrect. The increase in the money supply increases aggregate demand and causes
the move to point A where real wages fall, profits rise, and more workers hired. At point
B in long run, nominal wages rise, profits fall and the result is point
c. Incorrect. The increase in the money supply increases aggregate demand and causes
the move to point A where real wages fall, profits rise, and more workers hired. At point
B in long run, nominal wages rise, profits fall and the result is point
d. Incorrect. The increase in the money supply increases aggregate demand and causes
the move to point A where real wages fall, profits rise, and more workers hired. At point
B in long run, nominal wages rise, profits fall and the result is point
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14. Suppose the economy in Exhibit 10 is at point E1, and the Fed increases the money
supply. If people have rational expectations, then the economy will move
a. to point A in the short run and point B in the long run.
b. directly to point B.
c. to point C in the short run and point D in the long run.
d. directly to point D.
ANS
a. Incorrect.
b. Correct. Increase in aggregate demand causes workers to adjust their nominal wages
quickly and the economy moves directly to point B.
c. Incorrect.
d. Incorrect.
15. Which of the following is not an example of an incomes policy?
a. Presidential jawboning.
b. Wage and price guidelines.
c. Wage and price controls.
d. All of the above answers are correct.
ANS
a. Incorrect. Each of the answers is correct.
b. Incorrect. Each of the answers is correct.
c. Incorrect. Each of the answers is correct.
d. Correct. Each of the answers is correct.
Exhibit 11 Aggregate demand and aggregate supply curves
120
LRAS SRAS2
SRAS1
115
E3
110
Price level
CPI
105
E2
100
E1
AD1
95
0
AD2
5.0 5.5 6.0 6.5 7.0 7.5
Real GDP
(trillions of dollars per year)
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16. As shown in Exhibit 11, if people behave according to adaptive expectations theory,
an increase in the aggregate demand curve from AD1 to AD2 will cause the economy to
move
a. directly from E1 to E3 and then remain at E3.
b. directly from E1 to E2 and then remain at E2.
c. from E1 to E2 initially and then eventually back to E1.
d. from E1 to E2 initially and then eventually to E3.
ANS
a. Incorrect. According to adaptive expectations theory, an increase in the aggregate
demand curve from AD1 to AD2 will cause the economy to move from E1 to E2 initially
and then eventually move to E3.
b. Incorrect. According to adaptive expectations theory, an increase in the aggregate
demand curve from AD1 to AD2 will cause the economy to move from E1 to E2 initially
and then eventually move to E3.
c. Incorrect. According to adaptive expectations theory, an increase in the aggregate
demand curve from AD1 to AD2 will cause the economy to move from E1 to E2 initially
and then eventually move to E3.
d. Correct. According to adaptive expectations theory, an increase in the aggregate
demand curve from AD1 to AD2 will cause the economy to move from E1 to E2 initially
and then eventually move to E3.
17. As shown in Exhibit 11, if people behave according to adaptive expectations theory,
an increase in the aggregate demand curve from AD1 to AD2 will cause the price level to
move
a. directly from 100 to 110 and then remain at 110.
b. directly from 100 to 105 and then remain at 105.
c. from 100 to 105 initially and then eventually back to 100.
d. from 100 to 105 initially and then eventually to 110.
ANS
a. Incorrect. According to adaptive expectations theory, an increase in the aggregate
demand curve from AD1 to AD2 will cause the price level to move
from 100 to 105 initially and then eventually move to 110.
b. Incorrect. According to adaptive expectations theory, an increase in the aggregate
demand curve from AD1 to AD2 will cause the price level to move
from 100 to 105 initially and then eventually move to 110.
c. Incorrect. According to adaptive expectations theory, an increase in the aggregate
demand curve from AD1 to AD2 will cause the price level to move
from 100 to 105 initially and then eventually move to 110.
d. Correct. According to adaptive expectations theory, an increase in the aggregate
demand curve from AD1 to AD2 will cause the price level to move
from 100 to 105 initially and then eventually move to 110.
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18. As shown in Exhibit 11, if people behave according to adaptive expectations theory,
an increase in the aggregate demand curve from AD1 to AD2 will cause
a. labor to adjust nominal wages sluggishly.
b. the aggregate supply curve to shift from SRAS1 to SRAS2
c. the price level to eventually rise from 100 to 110.
d. All of the answers are correct.
ANS
a. Incorrect. Each answer is correct.
b. Incorrect. Each answer is correct.
c. Incorrect. Each answer is correct.
d. Correct. Each answer is correct.
19. As shown in Exhibit 11, if people behave according to rational expectations theory,
an increase in the aggregate demand curve from AD1 to AD2 will cause the price level to
move
a. directly from 100 to 105 and then remain at 105.
b. directly from 100 to 110 and then remain at 110.
c. from 100 to 105 initially and then eventually back to 100.
d. from 100 to 105 initially and then eventually to 110.
ANS
a. Incorrect. According to rational expectations theory, an increase in the aggregate
demand curve from AD1 to AD2 will cause the price level to move directly from 100 to
110 and then remain at 110.
b. Correct. According to rational expectations theory, an increase in the aggregate
demand curve from AD1 to AD2 will cause the price level to move directly from 100 to
110 and then remain at 110.
c. Incorrect. According to rational expectations theory, an increase in the aggregate
demand curve from AD1 to AD2 will cause the price level to move directly from 100 to
110 and then remain at 110.
d. Incorrect. According to rational expectations theory, an increase in the aggregate
demand curve from AD1 to AD2 will cause the price level to move directly from 100 to
110 and then remain at 110.
20. As shown in Exhibit 11, if people behave according to rational expectations theory,
an increase in the aggregate demand curve from AD1 to AD2 will cause the economy to
move
a. directly from E1 to E3 and then remain at E3.
b. directly from E1 to E2 and then remain at E2.
c. from E1 to E2 initially and then eventually to E1.
d. from E1 to E2 initially and then eventually to E3.
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ANS
a. Correct. According to rational expectations theory, an increase in the aggregate
demand curve from AD1 to AD2 will cause the economy to move directly from E1 to E3
and then remain at E3.
b. Incorrect. According to rational expectations theory, an increase in the aggregate
demand curve from AD1 to AD2 will cause the economy to move directly from E1 to E3
and then remain at E3.
c. Incorrect. According to rational expectations theory, an increase in the aggregate
demand curve from AD1 to AD2 will cause the economy to move directly from E1 to E3
and then remain at E3.
d. Incorrect. According to rational expectations theory, an increase in the aggregate
demand curve from AD1 to AD2 will cause the economy to move directly from E1 to E3
and then remain at E3.
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