Use the information below to explain adjustments that move the economy to a long-run equilibrium. Assume that firms and workers have adaptive expectations
The current unemployment rate = 7%.
The natural rate of unemployment = 5.5%.
Last year's inflation rate = 5%.
This year's inflation rate = 4%.
If firms and workers have adaptive expectations, they will expect inflation this year to be the same as last year (5%). Since workers are overestimating the actual rate of inflation, real wages will be rising, leading to an unemployment rate that is above its natural level (7% > 5.5 %). As firms and workers adjust their inflation expectations, real wages will decrease until the economy reaches its natural rate of unemployment.
You might also like to view...
A. Everything else remaining unchanged, what is likely to happen to the credit demand curve of an economy if:
i. businesses in the economy see scope for growth and are planning to expand production in the future? ii. households are pessimistic about future incomes? iii. the government is planning to borrow money from financial institutions for investment in infrastructures? b. Everything else remaining unchanged, what is likely to happen to the credit supply curve of an economy if firms tend to hold on to retained earnings instead of paying dividends?
Refer to Table 2-4. Which of the following statements is true?
A) George has an absolute advantage in both tasks. B) Jack has an absolute advantage in both tasks. C) Jack has an absolute advantage in lawn mowing and George in garden cultivating. D) Jack has an absolute advantage in garden cultivating and George in lawn mowing.