Assuming Ökun\'s law is given by U-Un0.3(Y - YP) and that the Phillips curve is

Question

Assuming Ökun's law is given by U-Un0.3(Y - YP) and that the Phillips curve is a. Obtain the short-run aggregate supply curve if expectations are adaptive, inflation given by = e-0.3(U-Un) + p, last year was 1%, potential output is $12 trillion, and political gridlock generates b. Calculate the inflation rate when output is $5, $10, and S15 trillion, and plot the c. If current output is $10 trillion and remains at this level for a while, what will uncertainty which causes the price level to increase by 1 percentage point short-run aggregate supply curve. happen to the short-run supply curve next year?

Explanation / Answer

a) Given Okun's law; U-Un=-0.3(Y-Yp) and Philips curve pi=pi^e-0.3(U-Un)+p

Given expectations are adaptive , that is pi^e=pi(-1) so we get pi^e=0.01

Potential output, Yp= $12 trn and p=.01

Now substituting the Okun's law equation into the philips curve we get the Short Run Aggregate Supply Curve, that is pi=pi^e-0.3[-0.3(Y-Yp)]+p

that is, pi=pi^e+0.09(Y-Yp)+p

that is, pi=0.01+0.09(Y-12)+0.01

that is, pi=-1.06+0.09Y

b) Inputting output values $5trn, $10trn and $15trn into the Short Run Aggregate Supply Curve from (a) we get inflation rates as -0.61, -0.16 and 0.29. The SR( Short Run) Aggregate Supply Curve has a negative y intercept of 1.06 and slopes upward from there with a slope of 0.09 uptill the Yp=$12 trn

c) Assuming adaptive expectations and using the SR Aggregate Supply Curve from (a) we get pi^e=-0.16. Putting this into the original SR Aggregate Supply Curve we get the New SR Aggregate Supply Curve as pi=-1.23+0.09Y. So the cutve will shift down and to the right.

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