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When workers and firms anticipate higher inflation, they incorporate these expectations into their wage and price-setting behavior. This adjustment causes the entire Phillips curve to shift upward, establishing a new, less favorable trade-off where any given level of unemployment corresponds to a higher rate of inflation.

Upward Shift of the Phillips Curve from Increased Expected Inflation

Based on the change in public expectations described in the case study, what is the most likely outcome for the actual rate of price increases if policymakers successfully use their tools to keep the unemployment rate at the original 5%? Explain your reasoning.

Impact of Changing Expectations on Economic Outcomes

An economy is operating with an unemployment rate below its natural rate, leading to a consistent rise in the actual inflation rate. Analyze how the continuous adjustment of inflation expectations by workers and firms affects the short-run trade-off between inflation and unemployment. In your answer, describe the resulting change in the graphical representation of this relationship.

The Instability of the Inflation-Unemployment Trade-off

Imagine an economy where for many years, both workers and businesses have expected an annual inflation rate of 2%. A sudden, temporary disruption in global supply chains then causes the actual inflation rate to surge to 7% for two consecutive years before the disruption is resolved. Analyze how this period of unexpectedly high inflation is likely to alter the short-run relationship between inflation and unemployment in the years *after* the supply disruption has ended. Explain the underlying mechanism for this change.

The Lasting Impact of a Temporary Inflation Shock

An economy has experienced a stable 2% inflation rate for several years. The central bank then makes a highly credible announcement that it will now target a 4% inflation rate. Once workers and firms fully incorporate this new expectation into their wage and price-setting decisions, what is the most likely outcome for the short-run relationship between inflation and unemployment?

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