Answer Happy

3. Answer both parts (a) and (b) of this question. (a) [8 marks]
Explain the main features of the trade-off between inflation and
unemployment implied by the Phillips curve when expectations are
not considered in the analysis. (b) Assume that the Phillips curve
for a given economy is given by: 𝜋𝜋𝑡𝑡 = 𝜋𝜋𝑡𝑡−1 − 0.5(𝑢𝑢𝑡𝑡 − 0.06),
where 𝜋𝜋𝑡𝑡 is the inflation rate at time t and 𝑢𝑢𝑡𝑡 is the
unemployment rate at time t. (i) [6 marks] Explain the concept of
the natural level of unemployment using the above Phillips curve.
(ii) [6 marks] Draw the short-run and the long-run Phillips curve
in the same graph. Explain the main differences between the two.
(iii) [5 marks] Suppose that the Central Bank wants to reduce the
inflation rate in period t by 5%. According to the Phillips curve
defined above explain the effects of this policy in the short run.
Find the sacrifice ratio for this policy assuming the Okun’s law
implies a 2% reduction in real GDP for a 1% increase in the
unemployment rate.