Suppose that in a given country, the line of best fit approximates the Phillips curve shown here. Suppose for next year, you expect GDP to be equal to potential GDP. Current inflation expectations are at 2%. How much does your salary have to change, in nominal terms, in order to maintain your purchasing power at the current level?

A)3%
B)2%
C)1%
D)4%

Question

Suppose that in a given country, the line of best fit approximates the Phillips curve shown here. Suppose for next year, you expect GDP to be equal to potential GDP. Current inflation expectations are at 2%. How much does your salary have to change, in nominal terms, in order to maintain your purchasing power at the current level?
Suppose that in a given country, the line of best fit approximates the Phillips curve shown here. Suppose for next year, you expect GDP to be equal to potential GDP. Current inflation expectations are at 2%. How much does your salary have to change, in nominal terms, in order to maintain your purchasing power at the current level? A) 3% B) 2% C) 1% D) 4%

A)3% 
B)2% 
C)1% 
D)4%

Quizplus · Accepted Answer

Since GDP is expected to be equal to potential GDP, there will be no output gap and the Phillips curve predicts no inflation. Therefore, to maintain purchasing power at the current level, your salary only needs to increase by the rate of inflation expectations, which is 2%. However, this increase is in nominal terms, so the real increase in purchasing power would be the nominal increase minus the inflation rate, which is 2% - 2% = 0%. Therefore, your salary should increase by 2% to maintain purchasing power at the current level.

Suppose That in a Given Country, the Line of Best