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Unit 3: Aggregate Demand and Supply and Fiscal Policy

Unit 3: Aggregate Demand and Supply and Fiscal Policy. 1. The Phillips Curve. The tradeoff between inflation and unemployment. What happens to inflation and unemployment when AD increase?. In general, there is an inverse relationship between unemployment and inflation. 3.

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Unit 3: Aggregate Demand and Supply and Fiscal Policy

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  1. Unit 3:Aggregate Demand and Supply and Fiscal Policy 1

  2. The Phillips Curve The tradeoff between inflation and unemployment. What happens to inflation and unemployment when AD increase?

  3. In general, there is an inverse relationship between unemployment and inflation 3

  4. Short Run Phillips Curve When the economy is overheating, there is low unemployment but high inflation Inflation When there is a recession, unemployment is high but inflation is low 5% 1% SRPC 2% 9% Unemployment 4

  5. AD/AS and the Phillips Curve

  6. Progression of the Phillips Curve 1960’s - unemployment was high and inflation was low. 1958, A.W. Phillips studied the relationship of wages and unemployment 1970’s - high inflation and high unemployment Milton Friedman and Edmund Phelps say there “two” Phillips Curve One Short Run Curve and One Long Run Curve

  7. SRAS LRPC LRAS Inflation Price Level SRPC UY Unemployment QY GDPR 11

  8. AS AS2 LRPC LRAS Inflation Price Level PLe SRPC1 AD2 AD SRPC UY Unemployment QY GDPR 12

  9. SRAS LRPC LRAS Inflation Price Level PLe AD2 AD SRPC AD3 UY Unemployment QY GDPR 13

  10. AS1 SRAS LRPC LRAS Inflation Price Level AS2 PLe SRPC1 AD SRPC SRPC2 UY Unemployment QY GDPR 14

  11. AD/AS and the Phillips Curve Show what happens on both graphs if AD increase LRPC Price Level LRAS Inflation AS PLe AD1 SRPC AD QY GDPR UY Unemployment 15

  12. AD/AS and the Phillips Curve Correctly draw the LRPC and SRPC with the recessionary gap. What happens when AD falls? Price Level LRAS LRPC Inflation AS PLe SRPC AD AD1 QY GDPR UY Unemployment 16

  13. AD/AS and the Phillips Curve Correctly draw the LRPC and SRPC at full employment. What happens when AS falls? Price Level LRAS LRPC Inflation AS1 AS PLe SRPC1 AD SRPC QY GDPR UY Unemployment 17

  14. AD/AS and the Phillips Curve Correctly draw the LRPC and SRPC with an recessionary gap. What happens when AS goes up? Price Level LRAS LRPC Inflation AS AS1 PLe SRPC AD SRPC1 QY GDPR UY Unemployment 18

  15. 2008 Practice FRQ 19

  16. 2008 Practice FRQ 20

  17. Assume that a country’s economy is experiencing significant demand pull inflation. A.)Draw a correctly labeled graph of aggregate demand and aggregate supply showing the following: I.)Price level and output. II.)Full employment output B.) How does demand pull inflation affect the Phillips Curve? C.)Identify a fiscal policy that will return the economy to full employment output and show the change on the graph in part (A) D.)This country decides to make a large investment in education and assume this country makes two goods (X and Y) draw a production possibilities curve showing effects of this policy change. E.) How is LRAS affected by the change in policy made in section D?

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