1. Using the IS / LM model explain what would cause the aggregate demand curve to be steep. 2….

1. Using the IS / LM model
explain what would cause the aggregate demand curve to be steep.

2. Assume that inflation depends
on two things: the level of aggregate demand, indicated by the inverse of unemployment
(1/ U ), and the expected rate of inflation ( _
e t ). Assume that the rate of inflation ( _ t ) is
given by the equation _ t = (48/ U _ 6) + _ e t

Assume initially (year 0) that the
actual and expected rate of inflation is zero.

(a) What is the current (natural)
rate of unemployment?

(b) Now assume in year 1 that the
government wishes to reduce unemployment to 4 per cent

1. Using the IS / LM model
explain what would cause the aggregate demand curve to be steep.

2. Assume that inflation depends
on two things: the level of aggregate demand, indicated by the inverse of unemployment
(1/ U ), and the expected rate of inflation ( _
e t ). Assume that the rate of inflation ( _ t ) is
given by the equation _ t = (48/ U _ 6) + _ e t

Assume initially (year 0) that the
actual and expected rate of inflation is zero.

(a) What is the current (natural)
rate of unemployment?

(b) Now assume in year 1 that the
government wishes to reduce unemployment to 4 per cent and continues to expand
aggregate demand by as much as is necessary to achieve this. Fill in the rows
for years 0 to 4 in the following table.

It is assumed for simplicity that
the expected rate of inflation in a given year ( _
e t ) is equal

(c) Now assume in year 5 that the
government, worried about rising inflation, reduces aggregate demand sufficiently
to reduce inflation by 3 per cent in that year. What must the rate of unemployment
be raised to in that year?

(d) Assuming that unemployment
stays at this high level, continue the table for years 5 to 7.

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