Suppose that natural real GDP is constant. For every 1 percent increase in the rate of inflation above its expected level, firms are willing to increase real GDP by 4 percent. The purpose of this problem is to learn how to draw the short-run Phillips curve and to understand how either a change in the expected rate of inflation or a supply shock causes it to shift.
a) Given that the output ratio is initially 100 and the expected inflation rate equals 3.2 percent, find out the rate of inflation if real GDP grows by 3.2 percent.
b) Given that the output ratio is initially 100 and the expected inflation rate equals 3.2 percent, find out the rate of inflation if real GDP grows by 5.6 percent.
c) Given that the output ratio is initially 100 and the expected inflation rate equals 3.2 percent, find out the rate of inflation is real GDP declines by 2.4 percent.
d) Given that the output ratio is initially 100 and the expected inflation rate equals 3.2 percent, find out the rate of inflation if real GDP declines by 4.4 percent.
e) Use your answers to parts a-d to draw the short-run Phillips Curve, given that the expected inflation rate equals 3.2 percent.