Economics Question unit: Inflation, Unemployment and Monetary Policy
Problem 1 (20 marks)
Consider the following statement:
“The Phillips curve implies that when unemployment is high, inflation is
low, and vice versa. Therefore, we may experience either high inflation or
high unemployment, but we will never experience both together”.
Is this statement true, false or uncertain? Briefly explain.
Economics Question 2 (40 marks)
Answer the following questions and illustrate using the feasibility set (MRT) and the
policymakers preferences (MRS).
(a) What would the policymaker’s indifference curves look like if the policymaker cared
only about low unemployment? Which point on the Phillips curve would that policymaker choose?(20 marks)
(b) What would the policymaker’s indifference curves look like if the policymaker cared
only about low inflation? Which point on the Phillips curve would this policymaker choose?(20 marks)
Economics Question 3 (40 marks)
Consider an economy in the medium-run equilibrium (where the wage-setting and
the price-setting curves cross). Suppose that more workers join trade unions, which in-
creases their bargaining power against employers. Assume that the level of employment
and the labour supply remain constant in the short run.
(a) Using the labour market diagram show what happens to unemployment and real
wages in the labour market in the medium run. (20 marks)
(b) Using the bargaining gap concept, explain what happens to wages, prices and in-
flation as the economy adjusts from the initial equilibrium to the new equilibrium.
Show on the Phillips curve diagram what happens to inflation. (20 marks
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