(a)
The equations for dynamic aggregative demand (DAD) curve and dynamic
(a)
Explanation of Solution
The equation for the expected inflation with respect to random shocks in period
Here,
The equation for the dynamic aggregative supply (DAS) curve with the presence of random shocks can be derived as follows.
Consider the
The equation for Philips curve:
Now, substitute Equation (1) in Equation (3) to get the equation for DAS curve.
Therefore, the Philips curve becomes
The equation for DAD curve can be derived by using the following equations in the dynamic AD-AS model:
The equation for the demand for goods and services:
The fisher equation:
Consider Equation (5).
Substitute Equation (6) into Equation (5).
Now, substitute Equation (2) instead of
Consider the monetary policy rule in the dynamic AD-AS model.
The equation for the monetary-policy rule.
Substitute Equation (8) in Equation (7).
Now, rearrange the above equation to get the equation for DAD curve.
Therefore, the equation for the DAD curve can be represented as follows:
Dynamic aggregative demand curve: The dynamic aggregative demand curve indicates the negative association between output and inflation which determines the economy’s short-run equilibrium.
Dynamic
(b)
Explain the effect of random shock if it is greater than zero on DAD, DAS, output level, inflation rate, nominal interest rate, and real interest rate.
(b)
Explanation of Solution
The DAD curve shows the relationship between output and inflation. Therefore, the value of random shock is greater than zero, which causes to shift the DAD curve right ward. This rightward shift of DAD curve increases the rate of inflation and output level. In such situation, according to the
Dynamic aggregative demand curve: The dynamic aggregative demand curve indicates the negative association between output and inflation which determines the economy’s short-run equilibrium.
Dynamic aggregative supply curve: The dynamic aggregative supply curve indicates positive association between output and inflation which determines the economy’s short-run equilibrium.
(c)
The changes in DAD, DAS, output, inflation, nominal, and real interest rate in period
(c)
Explanation of Solution
As described in part (a), in period
Here,
Stagflation: The stagflation is an economic condition where slow
(d)
The changes in subsequent periods.
(d)
Explanation of Solution
As described in part (c), in period
Dynamic aggregative supply curve: The dynamic aggregative supply curve indicates one of the two relationships between output and inflation which determines the economy’s short-run equilibrium.
(e)
The statement that inflation scares self- fulfilling.
(e)
Explanation of Solution
As described in part (b), if the value of random shock is greater than zero, it causes to shift the DAD curve rightward. This rightward shift of DAD curve increases the rate of inflation and output level. This means when people expect a higher inflation, such type of random shocks act in a way that it actually does. Therefore, the given analysis illustrates that the inflation scares can be self-fulfilling.
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Chapter 15 Solutions
MACROECONOMICS+ACHIEVE 1-TERM AC (LL)
- Consider an economy producing at Yo = 0 and ū = 1/4. The inflation rate at t = 0 is TO = 3%. Now, suppose the economy is hit by an inflation shock ō1 = ō2 = 3%. The shock is temporary and ōt = 0 for t > 2. For the duration of the inflation shock, the economy is in a recession with Y = Ý2 = -1%, which ends with Y3 = 0. Based on this information, you know that the inflation rate T3 is percent. 8.5 8.5 (with margin: 0)arrow_forwardIn a certain economy, the Dynamic Aggregate Supply (DAS) line is represented by the function = - π₁ = Ę ₁ = ₁ π + α ( Y₁ − Ÿ) + D and the inflation expectations formation mechanism is adaptive, that is, E₁+1 Absent a supply shock (v₁ = 0), in a figure representing period t inflation rate, π, on the vertical axis, and period t output, Y₁, on the horizontal axis, the period t DAS line will pass through the pair of points, : OA. (-1) B. (α, Y) ○ C. (Y) D. (πt, Yt)arrow_forwardThe table below reports the actual inflation rate from 2016 to 2020. Complete the table, assuming people form expectations adaptively. Give all answers to two decimals, Actual inflation rate Expected inflation rate Error Year 2016 3% 3% 0% 5.50% a) % b) % 2017 6.00% 5.50% c) 2018 4.00% d) 2.00% 2019 2020 2.00% e) Look back at the table. Assuming people form expectations adaptively, which of the following statements are correct? Choose one or more: OA Monetary policy can reduce unemployment only if the policy is expected. OB. When inflation is increasing from year to year, people tend to overestimate inflation. OC. When inflation is decreasing from year to year, people tend to overestimate inflation. O D. When inflation is decreasing from year to year, people tend to underestimate inflation. OE When inflation is increasing from year to year, people tend to underestimate inflation.arrow_forward
- The table below reports the actual inflation rate from 2016 to 2020. Complete the table, assuming people form expectations adaptively. Give all answers to two decimals. Year 2016 2017 2018 2019 2020 Actual inflation rate 3% 4.50% 7.00% 6.00% 4.00% Expected inflation rate a) d) e) 3% 4.50% % % % b) c) f) Error 0% 1.00% % % %arrow_forwardAn economy's aggregate demand curve (the relationship between short-run equilibrium output and inflation) is described by the equation:Y = 15,000 - 12,000π, where π is the inflation rate. Initially, the inflation rate is 2 percent or π = 0.02. Potential output Yp equals 14,640.Note: Keep as much precision as possible during your calculations. Your final answer for inflation should be accurate to at least two decimal places and output should be accurate to the nearest whole number.a) Find inflation and output in short-run equilibrium. Inflation : 0%Output : $0 b) Find inflation and output in long-run equilibrium. Inflation : 0%Output : $0arrow_forwardwhat are the policy implications of assuming different inflation expectationsarrow_forward
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- Which of the following best describes the concept of 'rational expectations' in the context of macroeconomic theory?a) The hypothesis that consumers and firms expect future inflation to match past inflation rates without considering current economic policies.b) The idea that individuals and firms make forecasts of future economic variables based solely on historical data, ignoring all current available information.c) The theory that individuals and firms use all available information, including current and historical data, to make accurate predictions about future economic variables.d) The assumption that individuals and firms consistently underestimate the impact of monetary and fiscal policies on the economy due to a lack of available information.Please don't use ai please provide valuable answer otherwise be ready for disupvotearrow_forwardSuppose the Federal Reserve sets the real interest rate to 1.5%. Moreover, assume that there are no demand shocks, that b = 2.5, and that F = 0.02. If the resulting change in the inflation rate is +0.375 percentage points, what is the value of the parameter D? (Round to the nearest hundredth.) Hint: Use the IS and Phillips Curves to calculate your answer.arrow_forwardThe following graph plots the short-run and long-run Phillips curves (SRPC and LRPC, respectively) for an economy currently experiencing long-run macroeconomic equilibrium at point A, where the natural unemployment rate is 6% and the inflation rate is 8% per year. Suppose that the central bank for this economy has decided that inflation is too high and thus wants to decrease the inflation rate by 6 percentage points per year. A reduction in the rate of inflation is known as (deflation/disinflation) . To reduce inflation from 8% to 2% in the short run, the central bank would have to accept an unemployment rate of ____% True or False: If people have rational expectations, the economy may not have to endure an unemployment rate as high as predicted by the short-run Phillips curve. -True -Falsearrow_forward