Key Concepts in Chapter 31 The Phillips Curve and Inflation

Rare earth metals are used in the production of many of the personal electronic devices you use every day. Use the interdependence principle to discuss the impact of an unexpected increase in the price of rare earth metals on inflation.
You’ve been invited to help a foreign affiliate of your company set next year’s prices. Inflation last year was 5%, the unemployment rate dropped to record lows, and GDP skyrocketed. In addition, geopolitical tensions led the price of crude oil to rise by 50%. Given these circumstances, what do you think annual inflation will be next year, and how will this affect your advice? Explain your reasoning.

Explain how inflation expectations are like a self-fulfilling prophecy.
In June 2019, the average price for a cup of coffee in Venezuela was 6,500 bolivars; in June 2018 the average price was just 8 bolivars. This represents an 81,150% increase in a cup of coffee for Venezuelans, who have seen similarly dramatic increases in the prices of everything they buy. Discuss how this experience impacted the inflation expectations of the average Venezuelan during that time, and how those expectations can impact actual inflation.

Explain the difference between expected inflation and unexpected inflation.
Draw an example of a Phillips curve and a labor market Phillips curve. Explain how they summarize the exact same idea while using different measures of excess demand.

If Congress levies a new $1,000 per car tax on car manufacturers to pay for expanded Social Security benefits, how do you think this will impact unexpected inflation?
The adoption of vehicle automation has exploded over the last few years: Automated tractors are already in use harvesting produce on farms, while self-driving vehicles are used to move cargo around shipping yards and warehouses. Use a Phillips curve to help explain how this technological change impacts inflation.

For each of the following, determine whether inflation expectations, demand-pull inflation, or cost-push inflation—and hence inflation overall—will change.
1. A rapid influx of foreign investment causes the output gap to become more positive.
2. The president unexpectedly announces a tariff on aluminum and steel.

In January 2019, inflation expectations in the United Kingdom fell from 2.9% to 2.6%. What effect will this have on inflation in the United Kingdom if nothing else changes in the economy? Explain your reasoning.
Seana owns a small pet shop and expects inflation to be 3% next year. By how much does Seana expect her marginal costs to change? By how much does she expect her competitor’s prices to change?
You’re a pricing analyst for a manufacturing firm. You are tasked with predicting how average prices will change over the next quarter to help your manager decide how to change her prices. How would you find the best estimate of the likely inflation rate? What do you tell your manager and why?

You’re a junior consultant at a management consulting company and your team has been hired to help guide a struggling regional retailer. You do some research and find that the output gap is currently zero, and inflation is 4%. In an effort to boost output before the next election, the government announces an unexpected stimulus package that you expect will increase next year’s output to be 5% above potential.

The graph plots output gap against unexpected inflation and depicts an upward-sloping Phillips curve that extends from the origin and passes through (negative 10, negative 2), (negative 5, negative 1), (0, 0), (5, 1), and (10, 2).
1. Use the Phillips curve to estimate unexpected inflation after the stimulus.
2. What is your forecast for actual inflation after the stimulus?
3. How do you advise the retailer when they ask you how they should change prices next year, given the stimulus will have boosted output?
Take the Phillips curve from the previous question and illustrate the corresponding labor market Phillips curve where the initial unemployment rate was 712% $percent$ and the final unemployment rate is 212%. $percent full stop$ What is the equilibrium unemployment rate in the economy?

Recently, policy makers have debated whether an increase in the federal minimum wage (currently $7.25 an hour) would be good for the economy. Use a Phillips curve to explain how inflation would change for the following scenarios. Assume that the output gap does not change.
1. Policy makers announce that effective next week the federal minimum wage will be $15 an hour.
2. Policy makers announce that the federal minimum wage will increase to $15 an hour over the course of the next 10 years by annual increases of $0.78.
3. Explain how the initial increase in the federal minimum wage for low-wage earners could lead to a wage-price spiral throughout the economy.
Since 2010, the U.S. dollar has appreciated relative to the Mexican peso. What are the direct and indirect effects on inflation? Explain.
Identify whether the following will represent a shift in the Phillips curve or a movement along the Phillips curve. Illustrate with a graph.
1. Consumer confidence increases unexpectedly and causes the output gap to become more positive.
2. Inflation last year was far greater than even the best forecaster expected even though the output gap was zero.
3. A devastating late-spring freeze destroys crops across the eastern United States, which causes the output gap to become more negative.