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Brief Principles of Macroeconomics...

8th Edition
N. Gregory Mankiw
ISBN: 9781337091985

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BuyFindarrow_forward

Brief Principles of Macroeconomics...

8th Edition
N. Gregory Mankiw
ISBN: 9781337091985
Textbook Problem

When the Federal Reserve increases the money supply and expands aggregate demand, it moves the economy along the Phillips curve to a point with _____ inflation and _____ unemployment.

a. higher, higher

b. higher, lower

c. lower, higher

d. lower, lower

To determine

Relationship between inflation and unemployment.

Answer

Option “b” is the correct answer.

Explanation

Option (b):

When the Federal Reserve increases the money supply and expands aggregate demand, it moves the economy along the Phillips curve to a point with higher inflation and lower unemployment.

The increase in money supply reduces the interest rate, increases the inflation, and increases the investment. Increasing investment leads to an increase in the employment and income. When the inflation rate increases, the unemployment rate will decrease. There is a negative relationship between inflation and unemployment. Thus, option “b” is correct.

Option (a):

There is a negative relationship between inflation and unemployment. Therefore when inflation increases, the unemployment rate will fall. Thus, option “a” is incorrect.

Option (c):

When the Federal Reserve increases the aggregate demand, it leads to a higher inflation rate in the economy. Thus, option “c” is incorrect.

Option (d):

When the Federal Reserve increases the money supply and expands the aggregate demand, it moves the economy along the Phillips curve to a point with higher inflation and lower unemployment. The increase in demand will lead to an increase in the price level; ultimately leads to an increase in the inflation rate in the economy. Thus, option “d” is incorrect.

Concept

Philips curve: Phillips curve shows the inverse relationship between inflation and unemployment.

Inflation: Inflation refers to the tendency of increasing price.

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