Question

Using the adaptive-expectations form of the short-run Phillips curve:
(a) Identify the term in the equation that corresponds to expected inflation and briefly explain what the form of this term says about how people form their expectation of inflation.
(b) Briefly describe how inflation will change if unemployment is held at a constant level above the natural rate of unemployment.
(c) Derive the expression for the long-run Phillips curve.

Answer 1

a)

n of inflation.

In economic domain, adaptive expectation term is used to predict future on the basis of past events. It can be easily understood with the help of the following example that people will expect high rate inflation in the coming years if they face inflation in the past year.

The adaptive expectation formula is

Pe = Pt. -1

From the above equation, it can be stated that people expect inflation when

This states last year actual inflation is equal to the expected inflation in the present year.

b)

If unemployment is help constant above the natural rate of unemployment, inflation will decelerate. It can be easily understood from long run Phillip curve. In the figure, the horizontal axis measures the unemployment rate and vertical axis measure the inflation rate.

Point A= initial point (Primary rate of inflation rate as well as unemployment rate). Inflation will enhance if expansionary economic policies considered by the government. This movement in the graph shows the point B. Now, due to the high inflation Philip curve shift to the right equilibrium point c. at this point

c)In the long run, unemployment and inflation are unconnected to each other and for that reason Phillips curve is a vertical line