Founding the effect of inflation and unemployment in the short run and long run through Phillips curve.
An economy is currently experiencing 3% inflation. Unemployment is 5%, which is believed to be the target rate of unemployment and consistent with potential output. Demonstrate the effect of expansionary policy using the Phillips curve model.
The economy is currently at point A. Point A is consistent with the potential level of output (shown in the AD AS diagram) and 5% level of unemployment rate (shown in the Philips curve diagram.
a. Illustrate what is the short-run effect on unemployment? Inflation? Demonstrate your answer graphically.
b. Illustrate what is the long-run effect on unemployment? Inflation? Demonstrate your answer graphically.