Suppose that an economy has the Phillips curve p = p-1 - 0.5(u - un),
and that the natural rate of unemployment is given by an average of the past two years' unemployment:
un = 0.5(u-1 + u-2).

1) Why might might the natural rate of unemployment depend on recent unemployment (as is assumed in the preceding equation)?

2) Suppose that the Fed follows a policy to permanently reduce the inflation rate by 1 percentage point. What effect will that policy have one the unemployment rate over time?

3) What is the sacrifice ratio in this economy? Explain.