1. 1 Chapter 27 Practice Quiz Tutorial The Phillips Curve and Expectations Theory ©2000 South-Western College Publishing

2. 2 1. The Phillips curve depicts the relationship between the a. unemployment rate and the change in GDP. b. inflation rate and the interest rate. c. level of investment spending and the interest rate. d. inflation rate and the unemployment rate. D. The Phillips curve is a theory developed by A. W. Phillips in 1958.

3. 3 2. A difficulty in using the Phillips curve as a policy menu is the a. fact that the natural rate of unemployment does not exist. b. fact that the curve would not remain in one position. c. difficulty deciding between monetary and fiscal policies. d. fact that Democrats choose one point on the curve and Republicans choose another point. B. The Phillips curve is a theory based on the assumption that it is stationary.

4. 4 3. Since the 1970’s, the a. Phillips curve has not been stable. b. inflation rate and the unemployment rate have been about equal. c. Phillips curve has proven to be a reliable model to guide public policy. d. relationship between the inflation rate and the unemployment rate moved in a counterclockwise direction. A. During 1960-69, the Phillips curve appeared stable. Since the 1970’s, the Phillips curve has not been stable.

5. 5 3% 2% 23 1% 4% 5% 1456 64 Unemployment Rate 7 6% 7% 69 68 67 60 63 62 61 65 66 The Phillips Curve U.S., 1960’s Inflation Rate

6. 6 3% 2% 23 1% 4% 5% 1 45 6 7 6% 7% 80 77 82 8% 9% 10% 11% 12% 13% 14% 8 10 9 74 81 75 78 73 70 88 76 89 71 72 87 85 84 83 86 Unemployment Rate Inflation Rate The Phillips Curve U.S., 1970 - 2003 79 98 97 96 94 92 90 00 99 01 03 02

7. 7 4. According to the natural rate hypothesis, a. the Phillips curve is quite flat, so that a large reduction in employment can be achieved without inflation. b. workers only adapt their wage demands to inflation after a considerable time lag. c. the Phillips curve is vertical in the long run at full employment. d. workers cannot anticipate the inflationary effects of expansionary public policies. C. Natural rate hypothesis argues that the economy will self-correct to the full- employment unemployment rate.

8. 8 5. Adaptive expectations theory a. argues that the best indicator of the future is recent information. b. underestimates inflation when it is accelerating. c. overestimates inflation when it is slowing down. d. none of the above. e. all of the above. E. According to adaptive expectations theory, expansionary monetary and fiscal policies to reduce the unemployment rate are useless in the long run.

9. 9 6. The conclusion of adaptive expectations theory is that expansionary monetary and fiscal policies intended to reduce the unemployment rate are a. effective in the long-run. b. effective in the short-run. c. unnecessary and cause inflation in the long-run. d. necessary and reduce inflation in the long-run. C. This theory believes, after a short-run reduction in unemployment, that the economy self-corrects to the natural rate of unemployment, but at a higher inflation rate.

10. 10 7. Most macroeconomic policy changes, say the rational expectations theorists, are a. unpredictable. b. predictable. c. slow to take place. d. irrational. B. Rational expectations theory argues that people are intelligent and informed. They not only consider past changes, but also use all available information to predict the future, including future monetary and fiscal policies.

11. 11 8. Rational expectations theorists advise the federal government to a. change policy often. b. pursue stable policies. c. do the opposite of what the public expects. d. ignore future economic predictions. C. Rational expectations argues that systematic and predictable expansionary monetary and fiscal policies are not only useless, but also harmful because the only result is higher inflation.

12. 12 9% 6% 2% 3% 12% 15% 4% 8% 6% 10% E1E1 Inflation Rate Long-run Phillips curve Short-run Phillips curve Natural rate Unemployment Rate The Short-run and Long-run Phillips Curves Exhibit 10 D

13. 13 9. Suppose the government shown in Exhibit 10 uses contractionary monetary policy to reduce inflation from 9 to 6 percent. If people have adaptive expectations, then a. the economy will remain stuck at point E 1. b. the natural rate will permanently increase to 8 percent. c. unemployment will rise to 8 percent in the short run. d. unemployment will remain at 6 percent as the inflation rate falls. C. The unemployment rate will rise to 8% as people adapt their inflationary expectations to the current inflation rate. Over time, however, the economy self-corrects to the natural unemployment rate.

14. 14 10. Suppose the government shown in Exhibit 10 uses contractionary monetary policy to reduce inflation from 9 to 6 percent. If people have rational expectations, then a. the economy will remain stuck at point E 1. b. the natural rate will permanently increase to 8 percent. c. unemployment will rise to 8 percent in the short run. d. unemployment will remain at 6 percent as the inflation rate falls. D. Assuming the impact of government policy is predictable, people immediately anticipate higher or lower inflation. Workers quickly change their nominal wages and businesses change prices. The price level changes but the unemployment remains unchanged at the natural rate.

15. 15 11. Voluntary wage-price restraints are known as a. wage-price controls. b. price rollbacks. c. wage-price guidelines. d. anti-inflation commitments. C. Wage-price guidelines are voluntary standards set by government rather than wage-price controls which are legal restrictions.

16. 16 12. Which of the following government policies is an incomes policy? a. A reduction in welfare expenditures. b. The publication of a list of guidelines suggesting maximum wage and price increases. c. An increase in the money supply. d. All of the above answers are correct. B. Income policies include presidential jawboning, wage-price guidelines, and wage-price controls.

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