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Suppose that a fall in consumer spending causes a recession. a. Illustrate the immediate change in the economy using both an aggregate-supply/aggregate-demand diagram and a Phillips-curve diagram. On both graphs, label the initial long-run equilibrium as point A and the resulting short-run equilibrium as point B. What happens to inflation and unemployment in the short run? b. Now suppose that over time expected inflation changes in the same direction that actual inflation changes. What happens to the position of the short-run Phillips curve? After the recession is over, does the economy face a better or worse set of inflation–unemployment combinations? Explain.

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Principles of Macroeconomics (Mind...

8th Edition
N. Gregory Mankiw
Publisher: Cengage Learning
ISBN: 9781305971509

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Chapter
Section
BuyFindarrow_forward

Principles of Macroeconomics (Mind...

8th Edition
N. Gregory Mankiw
Publisher: Cengage Learning
ISBN: 9781305971509
Chapter 22, Problem 3PA
Textbook Problem
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Suppose that a fall in consumer spending causes a recession.

a. Illustrate the immediate change in the economy using both an aggregate-supply/aggregate-demand diagram and a Phillips-curve diagram. On both graphs, label the initial long-run equilibrium as point A and the resulting short-run equilibrium as point B. What happens to inflation and unemployment in the short run?

b. Now suppose that over time expected inflation changes in the same direction that actual inflation changes. What happens to the position of the short-run Phillips curve? After the recession is over, does the economy face a better or worse set of inflation–unemployment combinations? Explain.

Subpart (a):

To determine
TheEffect of change in consumer spending on aggregate supply, aggregate demand and Phillips curve.

Explanation of Solution

The reason for shifting the aggregate demand and aggregate supply is reduction in consumer spending. The effect of fall in consumer spending on aggregate supply, aggregate demand, and Phillips curve is shown below.

Figure 1 shows the shift in aggregate supply and aggregate demand curves.

                                        A                                                                        B

Figure 1

Subpart (b):

To determine
TheEffect of change in consumer spending on aggregate supply, aggregate demand and Phillips curve.

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