AP Economics:

Phillips Curve FRQs

March 27, 2015
Phillips Curve FRQs
1. Assume that the economy of Hopeton is currently in long-run
equilibrium, with a
natural rate of unemployment equal to 5 percent and an inflation rate of
2 percent.
(a) Draw a correctly labeled graph of the short-run Phillips curve,
and label the curve as SRPC. Indicate the point on the SRPC
corresponding to the current unemployment and inflation rates,
labeled as R.

Correctly labeled axes; Intersection of LRPC and SRPC curves

labeled R and at 2% inflation and 5% UR
(b)On your graph in part (a), draw the long-run Phillips curve, and
label it as LRPC. Vertical at 5%
(c) Assume that the government of Hopeton increases spending to
finance repairs and maintenance of the countrys infrastructure.
How will such an increase in spending affect unemployment and
inflation in the short-run? Explain. The increase in G shifts
AD curve to the right, raising both Real GDP and Price
Levels. This leads to decrease in unemployment and
increase in inflation.

(d)Show on your graph in part (a) the new point on the SRPC
corresponding to the results that you stated in part (c), labeled
as S. See graph
(e) Following an increase in government spending, workers demand
and receive a higher wage. What happens to the SRPC as a
result of the higher wage? Explain. SPRC shifts up (right).
With each level of unemployment, inflation will be
higher.
2. Assume that the United States economy is in long-run equilibrium with
an expected inflation rate of 6 percent and an unemployment rate of 5
percent. The nominal interest rate is 8 percent.
(a) Using a correctly labeled graph with both the short-run and
long-run Phillips curves and the relevant numbers from above,
show the current long-run equilibrium as point A.

Correct labels, point A intersection labeled 6% and 5%

(b) Calculate the real interest rate in the long-run equilibrium. 8%6%=2%
(c) Assume now that the Federal Reserve decides to target an
inflation rate of 3 percent. What open-market operation should
the Federal Reserve undertake?
Sell securities
(d) Using a correctly labeled graph of the money market, show how
the Federal Reserves action you identified in part (c) will affect
the nominal interest rate.

Correct labels, MS shifts left, r increases

(e) How will the interest rate change you identified in part (d) affect
aggregate demand in the short run? Explain. AD decreases.
Increase in r causes decrease in C, a component of AD.
(f) Assume that the Federal Reserve action is successful. What will
happen to each of the following as the economy approaches a new
long-run equilibrium?
(i) The short-run Phillips curve. Explain. SRPC shifts left
because inflation expectations decrease.
(ii) The natural rate of unemployment unchanged
3. The unemployment rate is an important indicator of the health of the
United States economy.
(a) Assume that with the economy at full employment, the
government implements an expansionary fiscal policy. How
does the actual unemployment rate at the new short-run
equilibrium compare with the natural rate of unemployment?
UR will be below natural rate in short run
(b)Assume that a significant number of workers are involuntarily
changed from full-time to part-time employment. Explain how
this will affect the number of people who are officially classified
as unemployed. No change part time workers are
counted as employed
(c) Assume that the government reduces the level of unemployment
compensation.
(i) Explain how this affects the natural rate of unemployment.
UR may fall as labor force expands because more

persons will seek work after their UI benefits are

reduced.
(ii) Using a correctly labeled graph, show how this affects the
long-run Phillips curve.

Correct labels, LRPC shifts left

4. The unemployment rate in the country of Southland is greater than the
natural rate of unemployment.
(a) Using a correctly labeled graph of aggregate demand and
aggregate supply, show the current equilibrium real gross
domestic product, labeled YC, and price level in Southland,
labeled PLC.

Correct labels, downward sloping AD, upward sloping SRAS,

vertical LRAS to the right of intersection of SRAS and AD
The President of Southland is receiving advice from two economic advisers
Kohelis and
Raymondabout how best to reduce unemployment in Southland.
(b) Kohelis advises the President to decrease personal income
taxes.
(i) How would such a decrease in taxes affect aggregate
demand? Explain. AD shifts to right. Decrease in taxes

raises disposable income, raising C, a component of

AD.
(ii) Using a correctly labeled graph of the short-run Phillips
curve, show the effect of the decrease in taxes. Label the
initial equilibrium from part (a) as point A, and the new
equilibrium resulting from the decrease in taxes as point B.

Correct labels, downward sloping SRPC, point B at higher inflation

rate than point A due to increase in AD.
(c) Raymond advises the President to take no policy action.
(i) What will happen to the short-run aggregate supply curve in
the long run?
Explain. SRAS will shift to the right. Wages will
eventually fall, reducing costs to firms, who then
increase production.
(ii) Using a new correctly labeled graph of the short-run Phillips
curve, show the
effect of the change in the short-run aggregate supply you
identified in
part (c)(i).

Correct labels, SRPC shifts downward