The figure given below represents the short run and long run Phillips curve.
Figure 14.4

-Refer to Figure 14.4. If the adaptive expectations hypothesis holds, and the economy moves from point C to point D because of expansionary fiscal policy, what rate of inflation are people expecting at point D?

Question

The figure given below represents the short run and long run Phillips curve.
Figure 14.4
 
-Refer to Figure 14.4. If the adaptive expectations hypothesis holds, and the economy moves from point C to point D because of expansionary fiscal policy, what rate of inflation are people expecting at point D?

Quizplus · Accepted Answer

According to the adaptive expectations hypothesis, people's expectations about inflation are based on past experience. The movement from point C to point D represents an expansionary fiscal policy, which will lead to higher aggregate demand and ultimately higher inflation. Based on the short run Phillips curve, we can see that at point D, the unemployment rate is lower than at point C, indicating an increase in aggregate demand. This increase in aggregate demand will lead to inflation, which is reflected in the higher expected rate of inflation at point D. Looking at the short run Phillips curve, we can see that the expected rate of inflation at point D is around 4 percent.

The Figure Given Below Represents the Short Run and Long