Question 10
1 pts
Using estimates from economic data, economists believe the Phillips curve is best modeled by the
equation:
Inflation Rate = 36/(Unemployment Rate)
Where both the inflation rate and the unemployment rate are entered in percentage form (e.g. 30.57
not 0.3057).
The economy is also in a recession, with real GDP currently at $13,990. Economists estimate
potential GDP to be $18,711.
In response to the recession, the Federal Reserve has increased the money supply by 56%. Luckily,
the velocity of money held steady at v = 1 and the economy recovered to full employment.
What is the natural rate of unemployment for this economy?
Put your answer in percentage form and round to two decimal places.
Hints: This question is super difficult! I hope it will be all the more satisfying to you when you figure it out. Here are some clues:
(1) Remember that $M^\prime V = P^\prime Y$, and we know V stays at 1, so it reduces to $M = P^\prime Y$
(2) Inflation is the rate of change in the price level (P), So, Inflation = $(P_2 - P_1)/P_1$
(3) You can rearrange the equation from (1) and note that $P_1 = M_1/Y_1$ and $P_2 = M_2/Y_2$
(4) You have $Y_1$ and $Y_2$ in the question. Think about it. And math tells us that $M_2/M_1$ has to equal 1+(growth in the money supply).
(5) You can use these clues to help you find the rate of inflation that brought the economy to full employment. Then use the Phillips
Curve to find out what the rate of unemployment is.
