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Suppose that an economy has been experiencing actual inflation that is equal to expected inflation. This economy would most likely be operating at point:
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20. Tradeoffs Between Inflation and Unemployment
Phillips Curve and Expected Inflation
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Suppose an economy has been experiencing actual inflation below expected inflation. When this economy transitions to the long run, expected inflation will become equal to actual inflation. This will shift the _______________ causing movement from _______.
A
Short Run Phillips Curve, E to D
B
Short Run Phillips Curve, E to C
C
Short Run Phillips Curve, A to B
D
Long Run Phillips Curve, E to D
E
Long Run Phillips Curve, E to C
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Step 1: Understand the Phillips Curve framework. The Short Run Phillips Curve (SRPC) shows the inverse relationship between inflation and unemployment in the short run, while the Long Run Phillips Curve (LRPC) is vertical, indicating no trade-off between inflation and unemployment in the long run.
Step 2: Recognize that when actual inflation is below expected inflation, the economy is initially at a point on the SRPC where inflation is lower than expected, which corresponds to a point like E on the graph.
Step 3: Over time, as expectations adjust, expected inflation will align with actual inflation. This adjustment causes the SRPC to shift because the short-run trade-off changes with inflation expectations.
Step 4: The shift in the SRPC moves the economy from point E to point D on the graph, reflecting the adjustment process where unemployment moves back toward the natural rate (the vertical LRPC) as inflation expectations catch up.
Step 5: Conclude that the correct description is that the Short Run Phillips Curve shifts, causing movement from point E to point D, as the economy transitions to the long run where expected inflation equals actual inflation.
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