Consider the graph above. It is also in the files folder under the name Short Run...

  

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Consider the graph above. It is also in the files folder under the name Short Run and the Long Run. The graph pertains to a hypothetical country. Marginal propensity in this country is MPC = 0.75. The central bank in this country (also called the Fed) follows an inflation targeting policy. The current target inflation rate in 8 percent (1 know, it is too high. We will deal with this problem later after appointing a new chairperson for the Fed). The natural rate of unemployment is 5 percent and Okun's alpha is 8. Suppose that consumer confidence in the economy declines and as a result consumption decreases by 750 units. This causes the AD function to shift to the left by units. This reduction in demand causes the inflation rate to slow down to percent in the short run. In the short-run, the real GDP decreases to unemployment increases to an overall unemployment rate of units. Cyclical percent resulting in percent. If the Fed does not take any action and the recession turns out to be long-lived, the inflation rate will change over time and will equal percent in the long run. 15.0% 14.0% 13.0% 12.0% 11.0% P 10.0% 2 10.0% 9.0% Inflation Rate (n) 6.0% 5.0% S 4.0% 3.0% 2.0% 1.0% 0.0% 0 LRAS 1,000 2,000 3,000 4,000 5,000 6,000 7,000 8,000 9,000 10,000 11,000 12,000 13,000 14,000 Real GDP (Y) AD SRAS 15,000 16,000 17,000 18,000 19,000 20,000 Consider the graph above. It is also in the files folder under the name Short Run and the Long Run. The graph pertains to a hypothetical country. Marginal propensity in this country is MPC = 0.75. The central bank in this country (also called the Fed) follows an inflation targeting policy. The current target inflation rate in 8 percent (1 know, it is too high. We will deal with this problem later after appointing a new chairperson for the Fed). The natural rate of unemployment is 5 percent and Okun's alpha is 8. Suppose that consumer confidence in the economy declines and as a result consumption decreases by 750 units. This causes the AD function to shift to the left by units. This reduction in demand causes the inflation rate to slow down to percent in the short run. In the short-run, the real GDP decreases to unemployment increases to an overall unemployment rate of units. Cyclical percent resulting in percent. If the Fed does not take any action and the recession turns out to be long-lived, the inflation rate will change over time and will equal percent in the long run. 15.0% 14.0% 13.0% 12.0% 11.0% P 10.0% 2 10.0% 9.0% Inflation Rate (n) 6.0% 5.0% S 4.0% 3.0% 2.0% 1.0% 0.0% 0 LRAS 1,000 2,000 3,000 4,000 5,000 6,000 7,000 8,000 9,000 10,000 11,000 12,000 13,000 14,000 Real GDP (Y) AD SRAS 15,000 16,000 17,000 18,000 19,000 20,000