In the context of the Expectations Augmented Phillips Curve (EAPC), which of the following statements is/are correct? (A) An increase in the natural rate of unemployment shifts EAPC to the left. (B) An increase in expected inflation shifts EAPC up and to the right. (C) If actual unemployment equals the natural rate, unanticipated inflation equals zero. (D) As long as actual unemployment exceeds the natural rate, actual inflation exceeds expected inflation.

2 marksMacroeconomicsInflation, unemployment and the Phillips curveThe expectations-augmented Phillips curveModerateabout 2 min

IIT JAM 2021 Question 34: Inflation, unemployment and the Phillips curve

In the context of the Expectations Augmented Phillips Curve (EAPC), which of the following statements is/are correct?

Select all that apply.

Answer and worked solution

Answer: (B) and (C)

Writing the EAPC as $\pi = \pi^e - \beta(u - u_n)$ : a rise in expected inflation $\pi^e$ shifts the curve up and to the right, so (B) is correct, and at $u = u_n$ we have $\pi = \pi^e$ , so unanticipated inflation is zero, giving (C).

An increase in the natural rate shifts the curve to the right, not the left, so (A) is wrong. When $u > u_n$ , actual inflation falls below expected inflation, so (D) reverses the inequality. The correct statements are (B) and (C).

The trap: (D) As long as actual unemployment exceeds the natural rate, actual inflation exceeds expected inflation.

Above-natural unemployment pulls actual inflation below expected inflation, not above it; statement (D) has the direction backwards.

Inflation, unemployment and the Phillips curve has come up 106 times in 7 exams since 2006.

What this question tests

This question is on The expectations-augmented Phillips curve, part of Inflation, unemployment and the Phillips curve in Macroeconomics.

How expected inflation shifts the trade-off and makes it vertical in the long run.

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