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Suppose that natural real GDP is constant. For every 1 percent increase in the rate of inflation above its expected level, firms are willing to increase real GDP by 2 percent. The output ratio is initially 100 and the inflation rate equals 2 percent.
a. Based upon the preceding information, draw the short-run Phillips Curve.
b. What is the growth rate of nominal GDP in the economy? An adverse supply shock raises the inflation rate associated with every output ratio by 3 percentage points.
c. Draw the new short-run Phillips Curve.
d. The government chooses to follow a neutral policy in response to this shock. What will be the growth rate of nominal GDP? What will be the new rate of inflation? What will be the output ratio?
e. If the government chose to follow an accommodating policy, what would be the new inflation rate? The output ratio? The growth rate of nominal GDP?
In using the Taylor Rule as a guideline for monetary policy, what are the pros and cons of using forecasted values of inflation and output rather than observed values of these variables?
Fill in the table indicating whether the new Each row and column heading describes a shock to a market initially in equilibrium. Fill in the table indicating whether the new equilibrium price and quantity will increase, decrease, or not change.
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