Theme 12.

The Phillips Curve

Directions: Each of the questions or incomplete statements below is followed by four or five
suggested answers or completions. Select the one that is the best in each case.
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1. The “misery index” is the inflation rate:

(A) times the unemployment rate
(B) minus the unemployment rate
(C) divided by the unemployment rate
(D) plus the unemployment rate
(E) no true answer
Inflation Rate (%)

Unemployment Rate (%)

2. The figure above illustrates a

(A) demand curve
(B) Phillips curve
(C) production possibilities frontier
(D) aggregate supply curve
(E) Lorenz curve

3. Which of the following relationships is illustrated by a short-run Phillips curve?

(A) A decrease in the rate of inflation is accompanied by an increase in the rate of economic growth.
(B) A decrease in the rate of inflation is accompanied by an increase in the rate of unemployment.
(C) An increase in the rate of inflation is accompanied by a decrease in the rate of economic growth.
(D) An increase in the rate of inflation is accompanied by an increase in the rate of unemployment.
(E) A decrease in the rate of economic growth is accompanied by a decrease in the rate of
unemployment.

4. Which of the following could cause simultaneous increases in inflation and unemployment?
(A) A decrease in government spending.
(B) A decrease in the money supply.
(C) A decrease in the velocity of money.
(D) An increase in inflationary expectations.
(E) An increase in the overall level of productivity.
5. Suppose that, from 2002 to 2003, unemployment fell from 7.2 to 7.0% and inflation fell from 3.8 to
1.1%. An explanation of these changes might be that the
(A) aggregate demand curve shifted to the left
(B) aggregate demand curve shifted to the right
(C) aggregate supply curve shifted to the left
(D) aggregate supply curve shifted to the right
(E) short-run Phillips curve shifted to the right
6. Which of the following creates the trade-off depicted by the Phillips curve?
(A) A rightward shift in the aggregate supply curve.
(B) An increase in input costs that corresponds with an increase in unemployment.
(C) An increase in output that correspond with a decrease in the price level.
(D) A leftward shift in the aggregate supply curve.
(E) A rightward shift in the aggregate demand curve.

7. The Phillips curve shows

(A) an inverse relationship between the real and nominal wage
(B) an inverse relationship between the rate of inflation and the rate of unemployment
(C) a positive relationship between the nominal wage and the rate of unemployment
(D) a positive relationship between the rate of inflation and the nominal wage
(E) an inverse relationship between the real output and rate of unemployment

8. On a short-run Phillips curve, high rates of inflation coincide with

(A) high interest rates
(B) low interest rates
(C) high unemployment rates
(D) low unemployment rates
(E) low discount rates

9. The Phillips curve shows that

(A) high unemployment rates are associated with low inflation rates
(B) high unemployment rates are associated with high inflation rate
(C) high unemployment rates are associated with a large increase in the nominal wage
(D) high inflation rates are associated with a small increase in the nominal wage
(E) high inflation rates are associated with a low rate of economic growth

10. The relationship between short-run aggregate supply curves and Phillips curves is that there
(A) is no relationship between short-run aggregate supply curves and Phillips curves
(B) are several short-run aggregate supply curves for each Phillips curves
(C) are several Phillips curves for each short-run aggregate supply curve
(D) is exactly one Phillips curve corresponding to each short-run aggregate supply curve
(E) no true answer

11. According to the Phillips curve, other things being equal, inflation depends positively on all of the
following except:
(A) expected inflation
(B) the unemployment rate
(C) the natural unemployment rate
(D) a supply shock, if one occurs
(E) no true answer

12. If the short-run aggregate supply curve is steep, the Phillips curve will be
(A) flat
(B) steep
(C) backward-bending
(D) unrelated to the slope of the short-run aggregate supply curve
(E) horizontal
13. The Phillips curve depends on all of the following forces except:
(A) the current money supply
(B) expected inflation
(C) the deviation of unemployment from its natural rate
(D) supply shocks
(E) all are the determinants

14. The short-run Phillips curve:

(A) shifts upward if expected inflation increases
(B) shifts upward if expected inflation decreases
(C) remains the same
(D) shifts downward if expected inflation increases
(E) is vertical

15. In the short run, increases in the nominal wage are associated with
(A) movement up a Phillips curve
(B) an outward shift of the Phillips curve
(C) a decrease in the rate of unemployment
(D) increased likelihood of demand-pull inflation
(E) a change in the slope of the Phillips curve

16. The Phillips curve suggests that monetary policymakers could use monetary policy to:
(A) reduce the unemployment rate at the expense of higher inflation
(B) reduce the unemployment rate while reducing inflation
(C) reduce the unemployment rate without affecting the inflation rate
(D) reduce inflation without affecting the unemployment rate
(E) increase the inflation rate while increasing the unemployment rate

17. The existence of a natural rate of unemployment suggests that

(A) there is no inflation-unemployment trade-off in the long run
(B) nominal wage increases lag price increases in the long run
(C) nominal wage increases lead price increases in the long run
(D) the short-run Phillips curve is steeper than the long-run Phillips curve
(E) the short-run Phillips curve is flatter than the short-run aggregate supply curve

18. Which of the following results from stagflation?

(A) Unemployment decreases.
(B) The price level decreases.
(C) The aggregate supply curve shifts to the right.
(D) The Phillips curve shifts to the right.
(E) Real GDP increases.

19. A fixed output level in the long run at full-employment output corresponds with which of the
following shapes of the long-run Phillips curve?
(A) Horizontal.
(B) Convex to the origin.
(C) Concave to the origin.
(D) Vertical.
(E) Linear with a slope of 1.
20. The assumption that people make the best economic forecast they can, given the information
available to them at the time, is called the
(A) Adaptive expectations hypothesis
(B) Optimum forecasting hypothesis
(C) Perfect expectations hypothesis
(D) Rational expectations hypothesis
(E) Okun’s law

21. The view that expectations change relatively slowly over time in response to new information is
known in economics as
(A) rational expectation
(B) irrational expectations
(C) slow-response expectations
(D) adaptive expectations
(E) none of the above

22. If prices are expected to rise more slowly in the future,

(A) the Phillips curve will shift to the right
(B) the actual rate of inflation will increase
(C) the actual inflation rate will remain steady unless supply shocks set in
(D) the government will carry out contractionary fiscal policy to prevent this occurrence
(E) these expectations will become reality

23. The sacrifice ratio measures:

(A) the number of percentage points of extra unemployment that must be endured to reduce
inflation by one percentage point
(B) the extra taxes that must be paid to balance the budget
(C) the number of months of real gross national product (GNP) that must be foregone to reduce the
inflation rate by one percentage point
(D) the percentage of a year's real gross national product that must be foregone to reduce inflation
by one percentage point
(E) all of the above
Answer the next seven questions on the basis of the following diagram.
Rate of increase
in price level, %

7
6

3 A

0 3 6 9
Unemployment rate, %
24. The curve on this graph is known as a:
(A) aggregate demand curve
(B) wage rate-inflation curve
(C) Phillips curve
(D) labour demand curve
(E) production possibilities curve
25. Which of the following best describes the relationship portrayed by this curve?
(A) The demand for labour is large when the rate of inflation is small.
(B) When the rate of unemployment is high, the rate of inflation is high.
(C) The rate of increase in the price level and the rate of unemployment are inversely related.
(D) The rate of increase in the price level and the rate of unemployment are directly related.
(E) No true answer.

26. A reduction in structural or bottleneck problems in labour markets will:

(A) tend to shift the curve to the right
(B) tend to shift the curve to the left
(C) move the economy southeast along the curve
(D) move the economy Northwest along the curve
(E) no true answer

27. An increase in aggregate demand will:

(A) tend to shift the curve to the right
(B) tend to shift the curve to the left
(C) move the economy southeast along the curve
(D) move the economy Northwest along the curve
(E) no true answer

28. An increase in the market power of unions and corporations will:

(A) tend to shift the curve to the right
(B) tend to shift the curve to the left
(C) move the economy southeast along the curve
(D) move the economy Northwest along the curve
(E) no true answer

29. Which of the following best describes a decision by policymakers which moves the economy from
point B to point A?
(A) Policy-makers have invoked an easy money policy and/or a budgetary deficit, thereby accepting
more unemployment in order to reduce the rate of inflation.
(B) Policy-makers have invoked a tight money policy and/or a budgetary surplus thereby accepting
a higher rate of inflation in order to reduce unemployment
(C) Policy-makers have invoked an easy money and/or a budgetary deficit, thereby accepting a
higher rate of inflation in order to reduce unemployment.
(D) Policy-makers have invoked a tight money policy and/or a budgetary surplus, thereby accepting
more unemployment in order to reduce the rate of inflation.
(E) No true answer.

30. The shape of this curve suggests that:

(A) the price level rises at a diminishing rate as the level of aggregate demand increases
(B) full employment and price stability are compatible goals only when aggregate demand is falling
(C) each successive unit of decline in the unemployment rate is accompanied by a smaller increase
in the rate of inflation
(D) each successive unit of decline in the unemployment rate is accompanied by a larger increase in
the rate of inflation
(E) shows the natural rate of unemployment
31. Other things being equal, which of the following would tend to increase cost-push inflation?
(A) More aggressive wage bargaining by labour unions.
(B) The dismantling of large monopolistic corporations.
(C) A decline in the number of workers belonging to labour unions.
(D) More rapid increases in labour productivity.
(E) All of the above.

32. The policy dilemma posed by stagflation is that:

(A) an increase in aggregate demand will increase inflation and the unemployment rate
simultaneously
(B) tax rates can be reduced without lowering tax revenues
(C) the reduction of aggregate demand to restrain inflation will cause a further reduction in the real
GDP
(D) the adjustment of aggregate demand can neither increase real GDP nor reduce inflation
(E) no policy dilemma

Answer the next seven questions on the basis of the above diagram. Assume the economy is initially at
point B1.

33. This diagram is the basis for explaining:

(A) the Keynesian conception of the Phillips Curve
(B) the adaptive expectations interpretation of the Phillips curve
(C) low central planning can make full employment and price level stability compatible goals
(D) new policies for eliminating stagflation
(E) natural rate of unemployment formation

34. As seen by the natural rate theorists, the full-employment rate for this economy is:
(A) in excess of 6%
(B) 5%
(C) 6%
(D) 4%
(E) 0%
35. The adaptive expectations theorists would argue that, given a time lag between price and nominal
wage adjustments, an increase in aggregate demand will temporarily move the economy from:
(A) B2 to B1
(B) C1 to B2
(C) B1 to C1
(D) B1 to B2
(E) C3 to B3

36. Which of the following movements is consistent with the traditional conception of the Phillips
curve?
(A) The movement from B1 to B2.
(B) The movement from B1 to C1.
(C) The movement from C1 to B2.
(D) The movement from B2 to B1.
(E) None of the above.

37. Adaptive expectations theorists argue that point C1 represents:

(A) a stable position because reality and expectations are consistent
(B) a stable position because full employment and a constant annual inflation rate are represented
(C) an unstable situation because we can anticipate contractionary policies by the government
(D) an unstable situation because we can anticipate increases in nominal wages
(E) none of the above

38. According to the adaptive expectations theorists, the long-run relationship between the
unemployment rate and the rate of inflation is represented by:
(A) the line connecting B1 and C1
(B) the line through B1, B2, B3, B4
(C) the line connecting C1 and B2
(D) any line parallel to the horizontal axis
(E) none of the above

39. If price level increases are fully anticipated by workers and government uses expansionary policies
to lower the unemployment rate below 6%:
(A) the economy will move from B1 to C1 at which point macroeconomic policies will cease to be
effective
(B) the economy will remain at B1
(C) the economy will follow the path indicated by B1, B2, B3, B4
(D) the economy will follow the path indicated by B1, C1, B2, C2, B3, etc.
(E) none of the above

40. A leftward shift of the Phillips curve suggests that:

(A) the productivity of labour has decreased
(B) a lower rate of inflation is now associated with each rate of unemployment than previously
(C) cost-push inflationary pressure has increased
(D) a higher rate of inflation is now associated with each rate of unemployment than previously
(E) the natural rate of unemployment has become zero

41. When the actual rate of inflation is less than the expected rate:
(A) the unemployment rate will temporarily rise
(B) firms will increase their output to recoup their falling profits
(C) the unemployment rate will temporarily fall
(D) firms will experience rising profits and thus increase their employment
(E) no true answer
Answer the next four questions on the basis of the following diagram. Assume that the natural rate of
unemployment is 5.5% and that the economy is initially operating at point a where the expected and
actual rates of inflation are each 6%.

42. If the actual rate of inflation unexpectedly falls from 6% to 4%, then the unemployment rate will:
(A) temporarily fall from 5.5% to 4%
(B) permanently fall from 5.5% to 4%
(C) temporarily rise from 5.5% to 7.5%
(D) permanently rise from 5.5% to 7.5%
(E) temporarily fall to 0%

43. In the long-rum, the decline in the actual rate of inflation from 6% to 4% will:
(A) reduce the unemployment rate
(B) reduce corporate profits in real terms
(C) have no effect on the unemployment rate
(D) reduce real national output
(E) reduce interest rate

44. According to rational expectations theory, if firms and workers fully anticipate the decline in the
actual rate of inflation from 6% to 4%, the economy will:
(A) move from a to b and eventually to c
(B) move directly from a to c
(C) remain at a
(D) move from a to d and eventually to c
(E) move to b

45. This diagram of the natural rate hypothesis suggests that:

(A) any rate of inflation is consistent with the natural rate of unemployment
(B) disinflation can occur
(C) unemployment rates which exceed the natural rate are only temporary
(D) all of the above are true
(E) no true answer
Answer the next four questions on the basis of the following diagram.

46. Point b on short-run Phillips curve PC1 represents a rate of:

(A) inflation below the natural rate
(B) inflation above the natural rate
(C) unemployment above the natural rate
(D) unemployment below the natural rate
(E) no true answer

47. According to the adaptive expectations theory, point b would be explained by:
(A) an actual rate of inflation which exceeds the expected rate
(B) an actual rate of inflation which is less than the expected rate
(C) cost-push inflation
(D) an increase in long-run aggregate supply
(E) decrease in natural rate of unemployment

48. According to the adaptive expectations theory, point b would not be permanent because the:
(A) economy would move from b to a on PC1
(B) short-run Phillips curve would shift from PC1 to PC2 and unemployment would increase to the
natural rate at c
(C) economy would immediately move from b to c to d
(D) economy would move from b directly to d
(E) no true answer

49. The move of the economy from c to e on short-run Phillips curve PC2 would be explained by an:
(A) increase in aggregate demand in the economy
(B) increase in aggregate supply in the economy
(C) actual rate of inflation that is less than the expected rate
(D) actual rate of inflation that exceeds the expected rate
(E) increase in natural rate of unemployment
 Answer the next six questions on the basis of the following diagram. Assume that nominal wages
initially are set on the basis of the price level P2 and that the economy initially is operating at its
potential level of output Qp

50. In the short run, an increase in the price level from P2 to P3 will:
(A) change aggregate supply from AS2 to AS3
(B) increase real output from Q1 to Q2
(C) change aggregate supply from AS2 to AS1
(D) increase real output from Qp to Q2
(E) increase the natural rate of unemployment

51. In the long run, an increase in the price level from P2 to P3 will:
(A) increase real output from Qp to Q2
(B) change aggregate supply from AS2 to AS1
(C) decrease real output from Q2 to Q1
(D) move the economy from e to d
(E) do none of the above

52. In terms of this diagram, the long-run aggregate supply curve:

(A) is AS2
(B) is a vertical line extending from Qp upward through e, b, and d
(C) may be either AS1, AS2, or AS3 depending on whether the price level is P1, P2, or P3
(D) is a horizontal line extending from P2 rightward through f, b, and g
(E) is no longer vertical

53. In the short run, demand-pull inflation could best be shown as:
(A) a move from b to c on AS2
(B) a move from b to c to d
(C) a change of aggregate supply from AS2 to AS3
(D) a move from b to point d
(E) a move from b to f

54. In the long run, demand-pull inflation could best be shown as:
(A) a move from b to c on AS2
(B) a move from b to f to d
(C) a change of aggregate supply from AS2 to AS3
(D) a move from b to d
(E) a move from b to a
55. In the short run, cost-push inflation could best be shown as:
(A) a leftward shift of aggregate supply from AS2 to AS3
(B) a move from b to c on AS2
(C) a move from b to c to d
(D) a move from b to f to d
(E) none of the above

56. All else equal, the short-run aggregate supply curve shifts positions when:
(A) the price level changes
(B) the rate of inflation changes
(C) nominal wages and other input prices change
(D) aggregate demand changes
(E) no true answer

57. If the Fed announces that it will raise the money supply in the future but does not change the
money supply today:
(A) both the nominal interest rate and the current price will decrease
(B) the nominal interest rate remains the same and the current price will increase
(C) the nominal interest rate will increase, and the current price level will decrease
(D) the nominal interest rate will decrease, and the current price level will increase
(E) both the nominal interest rate and the current price level will increase

58. Which of the following is true?

(A) The Phillips curve suggests an inverse relationship between increases in the price level and the
level of employment.
(B) If the Phillips curve shifts to the right and the economy has been applying wage-price controls,
we can conclude that this wage-price policy has been successful.
(C) Demand-pull and cost-push inflations are essentially identical concepts because both entail
rising nominal wages and rising prices.
(D) A shift in the Phillips curve to the left will improve the inflation-unemployment choices
available to society through the application of monetary and fiscal policy.
(E) All of the above.

59. Which of the following approaches to reducing inflation is likely to be the most credible?
(A) Gradualism.
(B) Cold-turkey.
(C) Wage and price controls.
(D) No difference in credibility of these.
(E) None of the above.
60. Compared with the speed of movement of the economy under adaptive expectations, the speed
under rational expectations is
(A) faster
(B) slower
(C) faster, but adjustment is incomplete
(D) slower, but adjustment is more complete
(E) the same
61. If the government commands total credibility, and prices and wages are fully flexible, inflation
(A) can be stopped instantly, but with high unemployment
(B) can be stopped instantly, with no unemployment
(C) can be stopped gradually, with no unemployment
(D) cannot be stopped
(E) depends on the country