Question

Suppose the Phillips curve is represented by the following equation: πt - πt-1 = 20 - 2ut. Given this information, which of the following is most likely to occur if the actual unemployment in any period is equal to 6%?a) the rate of inflation will tend to decreaseb) the rate of inflation will be constantc) the rate of inflation will tend to increasee) none of the above

Answer 1

Answer:

The correct answer is option c.

Explanation:

We know that, according to the Philips curve, there is an inverse relationship between the inflation rate and unemployment. It is indicated by the downward sloping Philips curve.  

In the given equation:  

πt - πt-1 = 20 - 2ut

20 indicates the natural rate of unemployment. We are aware that when the actual unemployment is lower than the natural rate of unemployment, the actual inflation rate tends to be higher than the expected rate.