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Based on the AD/AS diagram, what happens to the inflation rate and the unemployment rate when aggregate demand shifts from $AD_1$ to $AD_2$?

The inflation rate rises (price level increases from $P_1$ to $P_2$).
The unemployment rate falls (real output increases from $Y_1$ to $Y_2$).

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In this diagram, what economic concept is represented by the vertical line labeled LRPC, and what is its value on the horizontal axis?

Concept: The Long-run Phillips Curve.
Value: The natural rate of unemployment ($u^*$).

| | The government implements expansionary fiscal policy to reduce unemployment below its natural rate. Predict the short-run effect on (a) inflation and (b) unemployment. |

(a) Inflation increases due to demand-pull pressures.
(b) Unemployment decreases as the economy moves up along the SRPC.

| | The central bank increases interest rates to combat high inflation. Predict the short-run effect on (a) aggregate demand and (b) unemployment. |

(a) Aggregate demand decreases because higher borrowing costs reduce consumption and investment.
(b) Unemployment increases as the economy moves down along the SRPC.

| | Workers successfully bargain for higher nominal wages during a period of very low unemployment. Predict the effect of this wage increase on (a) production costs and (b) the price level. |

(a) Production costs increase.
(b) The price level increases as firms raise prices to protect profit margins (cost-push inflation).

| | An economy experiences a sudden negative supply shock (e.g., soaring energy prices). Predict the effect on the position of the Short-Run Phillips Curve (SRPC). | The SRPC shifts outward / to the right, resulting in higher inflation and higher unemployment simultaneously. | | Why does pursuing a policy of high economic growth often conflict with the objective of price stability? | Rapid economic growth driven by high aggregate demand increases demand-pull inflation, making low inflation harder to maintain. | | Outline the four main steps of the wage-price spiral triggered by low unemployment. |

1. Low unemployment leads to higher wage demands.
2. Higher wages increase production costs.
3. Businesses raise prices to protect profits.
4. Workers demand further wage increases to maintain purchasing power.

| | How does a low unemployment rate increase inflationary pressure through labour market bargaining power? | Labor becomes scarce, giving workers stronger bargaining power. Employers offer higher wages to compete, boosting disposable incomes and consumer spending. | | According to the natural rate hypothesis, what is the long-run trade-off between inflation and unemployment? | There is no permanent trade-off; any attempt to keep unemployment below the natural rate in the long run only results in accelerating inflation. | | Why is achieving 0% unemployment neither realistic nor desirable for a healthy market economy? | Frictional and structural unemployment are natural and necessary for labor mobility, allowing workers to transition to more productive jobs. | | Why do central banks target a low positive inflation rate (e.g., 2%) instead of 0% inflation? |

Prevents the risk of damaging deflation.
Provides a buffer that helps the economy adjust to shocks.

| | How does failing to maintain low inflation conflict with the objective of balanced trade (balance of payments stability)? | High inflation makes exports less internationally competitive and imports relatively cheaper, worsening the trade balance. | | The lowest sustainable unemployment rate an economy can achieve without triggering accelerating inflation is called the natural rate of unemployment, which typically ranges between 4% and 6%. | The lowest sustainable unemployment rate an economy can achieve without triggering accelerating inflation is called the natural rate of unemployment, which typically ranges between 4% and 6%. | | Along the Short-Run Phillips Curve (SRPC), changes in aggregate demand cause movements along the curve, whereas changes in inflation expectations or supply shocks cause shifts of the curve. | Along the Short-Run Phillips Curve (SRPC), changes in aggregate demand cause movements along the curve, whereas changes in inflation expectations or supply shocks cause shifts of the curve. | | In the long run, the Phillips Curve is vertical at the natural rate of unemployment, meaning demand-management policies cannot permanently lower unemployment below this point. | In the long run, the Phillips Curve is vertical at the natural rate of unemployment, meaning demand-management policies cannot permanently lower unemployment below this point. | | The downward-sloping Short-Run Phillips Curve (SRPC) assumes that workers and firms have not yet adjusted their inflation expectations. | The downward-sloping Short-Run Phillips Curve (SRPC) assumes that workers and firms have not yet adjusted their inflation expectations. | | A macroeconomic benefit of low unemployment is that it drives economic growth while simultaneously reducing government spending on welfare benefits. | A macroeconomic benefit of low unemployment is that it drives economic growth while simultaneously reducing government spending on welfare benefits. | |

| b | |

| a | |

| d | |

| c | |

| AD3 | |

| unemployment rate | |

| unemployment | |

| rate of inflation | |

| natural rate of | |

| unemployment rate | |

| SRPC | |

| LRPC |

1. Introduction to Economics2 subtopics

2. Microeconomics12 subtopics

3. Macroeconomics7 subtopics

4. The Global Economy10 subtopics

IB Economics 3.3.7 Potential Conflict Between Macroeconomic Objectives Flashcards

Flashcards for 3.3.7 Potential Conflict Between Macroeconomic Objectives

Flashcards for 3.3.7 Potential Conflict Between Macroeconomic Objectives - IB

1. Introduction to Economics2 subtopics

2. Microeconomics12 subtopics

3. Macroeconomics7 subtopics

4. The Global Economy10 subtopics