When the domestic currency depreciates, which of the following best describes the effect on the short-run Phillips curve?

• A. There is no change in the position of the Phillips curve.
• B. The Phillips curve becomes vertical, indicating no trade-off between inflation and unemployment.
• C. The Phillips curve shifts to the right, indicating higher inflation at each unemployment rate.
• D. The Phillips curve shifts to the left, indicating lower inflation at each unemployment rate.

Answer: (C)

Verified step by step guidance

1. Step 1: Understand the short-run Phillips curve (SRPC) concept, which shows the inverse relationship between inflation and unemployment in the short run. A movement along the curve reflects a trade-off between inflation and unemployment.
2. Step 2: Recognize that a depreciation of the domestic currency makes imports more expensive, which tends to increase the overall price level and thus inflation, holding unemployment constant.
3. Step 3: Analyze how this increase in inflation at every level of unemployment affects the SRPC. Since inflation rises for the same unemployment rate, the entire curve shifts.
4. Step 4: Determine the direction of the shift. Higher inflation at each unemployment rate means the SRPC shifts to the right, indicating a higher inflation rate for any given unemployment rate.
5. Step 5: Conclude that the depreciation of the domestic currency causes the short-run Phillips curve to shift to the right, reflecting increased inflation pressures in the economy.