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They Econmic Relief

In: Business and Management

Submitted By kingillyrian
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1. Give two reasons why there may be a short-run tradeoff between unexpected inflation and the unemployment rate?
Unexpected inflation reduces real wages W/P, so labor becomes cheaper (adaptive expectations). So with cheaper labor firms hire more workers to satisfy equilibrium condition of MRPL=W/P
MRPL - Marginal revenue product of labor
W/P - real wage
W - nominal wage
P - price level (change means inflation).
Expected inflation is assumed making labor contract, which does not in general affect real wages W/P (rational expectations).

Unemployment by itself tends to press on wages due to higher competition between workers for jobs.

Another point is sticky prices, due to unexpected inflation consumers might receive higher real income thus demand more goods which became relatively cheaper due to unexpected inflation, in order to supply such goods by contracts producers are pressed to hire more workers - so adaptive expectations in relation to sticky prices also confirms this trade-off.

Higher inflation caused by increase in aggregate demand provides pressure on higher

2. What is the difference between the short run and the long run Phillips curve?
Phillips curve is a curve depicting the relationship between inflation and unemployment. Inflation only effects the rate of employment when inflation was not expected. When you have higher and expected inflation for example, firms believe their products are commanding a higher price relative to other goods and so they increase output by hiring more labor. Lower inflation means firms think their products are cheaper relative to other goods so they reduce output increasing unemployment.

In the short run expectations can vary and be incorrect. So the government can for example, increase the supply of money, which raises inflation, and thereby reduce unemployment and increase real GDP.

In the long run,...

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