122 ❯ Step 4. Review the Knowledge You Need to Score High
The point at 5 percent inflation and 2 percent unemployment will not last. Workers
realize that their real wages are falling and insist on a raise! As wages rise, the profits of firms
begin to fall, and so too does employment back to the natural rate of 4 percent (point c). At
this point both actual and expected inflation is 5 percent. Another shortrun Phillips curve
runs through this point. Points a and c must lie on one longrun Phillips curve, and that
curve must be vertical. The process can repeat itself if AD continues to increase, or it can
reverse itself if AD falls. You might notice that this adjustment from a point on the SRPC
back to the LRPC follows the adjustment from a shortrun equilibrium to the longrun
equilibrium in the AD/AS model.
What happens if citizens and firms expect a higher rate of inflation than the actual rate?
Expecting higher prices in the future, consumers and firms increase purchasing now and
AD increases, which serves to increase the price level. The expectation in this case is really
a selffulfilling prophecy.
❯ Review Questions
SRPC 1
Unemployment
Rate (%)
Inflation
Rate (%) Phillips
Curve (LR)
4%
2%
2%
5%
a SRPC 2
b
c
Figure 9.23
- Using the model of AD and AS, what happens
in the short run to real GDP, the price level,
and unemployment with more consumption
spending (C )?
REAL GDP PRICE LEVEL UNEMPLOYMENT
(A) Increases Decreases Decreases
(B) Decreases Increases Increases
(C) Increases Increases Decreases
(D) Decreases Decreases Decreases
(E) Decreases Decreases Increases
- Which is the best way to describe the AS curve in
the long run?
(A) Always vertical in the long run.
(B) Always upward sloping because it follows the
Law of Supply.
(C) Always horizontal.
(D) Always downward sloping.
(E) Without more information we cannot pre
dict how it looks in the long run. - Stagflation most likely results from
(A) increasing AD with constant SRAS.
(B) decreasing SRAS with constant AD.
(C) decreasing AD with constant SRAS.
(D) a decrease in both AD and SRAS.
(E) an increase in both AD and SRAS.