Thursday 1 April
 
 
  1. The Phillips Curve is
  1. star or cross shaped
  2. the observed short-run trade-off between unemployment and the rate of inflation
  3. extremely stable in most countries
  4. a horizontal straight line
b. is the right answer -- simply a definition.
 

2. If people expect what they have just experienced to continue, we say their expectations are

a. rational b. adaptive c. irrational

d. too high

Again, b. is the right answer, and it is basically a definition.

  1. If inflation is actually accelerating, adaptive expectations will tend to make people
  1. consistently underestimate inflation
  2. consistently overestimate inflation
  3. on average, estimate inflation correctly
  4. produce unbiased estimates of inflation
Think this one through; if inflation is accelerating, that means it is getting faster -- say something like period 1, 4%; period 2, 5%, period 3, 6%, period 4, 7%, etc. Now adaptive expectations imply you assume that what you most recently experienced will continue next period. So in period 1, you experience 4% inflation, so expect 4% inflation; but in period 2, it turns out to be 5%, you underestimated. So now you adapt your expectation, and expect 5%; but it turns out to be 6%, you underestimated again. And so on. a. is the right answer -- when inflation accelerates, adaptive expectations produce consistent underestimates (until people wise up); if you think it through, you will see the opposite is also true -- if inflation is decelerating, adaptive expectations will consistently produce overestimates.
 
 

Review session for second midterm (Tuesday 6 April):

Two: first at 5.15 p.m. Monday April 5 in room 120 Bellamy;

Second at 6.45 p.m. Monday April 5 in room 221 Bellamy.

Exam will cover chapters 6 through 14.