ECON5002 - Macroeconomic Theory

Tutorial Questions

Topics: 'The AS-AD model' and 'Inflation and Unemployment:

The Phillips Curve Framework'

Tutorial 8 (Week Beginning 27 April)

NB: The readings for this tutorial are indicated in Topics 4 and 5 of the reading guides.

1. In 1973 the Organization of Petroleum Exporting Countries (OPEC) raised the price of a barrel of oil by 400% and some Arab members placed an oil embargo on countries (i.e. the United States) which supported Israel in the 'Yom Kippur' war against Egypt and Syria.

Show in the AS-AD model the impact of this event on a developed oil-importing country and consider the best policy response to stabilise the economy at a long run equilibrium position.

2. Explain why a high rate of inflation can persist well after the economic conditions which caused it to no longer exist.

3. What role does money play in the inflationary process? What is meant by the 'Neutrality of Money'?

4. What is the rationale for the trade-off between inflation and unemployment in the simple Phillips Curve?

Why did it come under criticism by many economists in the 1970s?

5. Consider an expectations-augmented Phillips Curve of the following form:

_t = a [(u_n / u_t) - 1] + b _t^e

where b = 1 and adaptive expectations:

_t^e = _t-1.

(a) What are the requirements for a constant rate of inflation over time?

(b) What will be the behaviour of inflation when u_t < u_n and what is the economic meaning of this behaviour?

(c) What will be the behaviour of inflation when u_t> u_n and what is the economic meaning of this behaviour?

Discussion Questions: Why does stagflation pose serious difficulties for policymakers? What macroeconomic policies, if any, would you propose to deal with stagflation?