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In the mid-twentieth century, economist A.W. Phillips identified a persistent inverse relationship between unemployment and inflation, suggesting that efforts to reduce joblessness tended to accelerate price increases. This empirical observation, later formalized as the Phillips Curve, appeared to provide policymakers with a manageable tradeoff: lower unemployment could be achieved at the expense of higher inflation, and vice versa. During the 1960s, this framework gained wide acceptance, informing expansionary fiscal and monetary strategies across several advanced economies.
The phenomenon of stagflation in the 1970s- when high inflation coexisted with high unemployment- posed a direct challenge to this view. Economists such as Milton Friedman and Edmund Phelps argued that the original formulation neglected the role of expectations. If households and firms come to anticipate inflation, they adjust wages and prices accordingly, negating any sustained employment gains from expansionary policy. The oil shocks of that decade, which sharply increased production costs across industries, further illustrated how supply-side disturbances could simultaneously drive inflation and unemployment, undermining the presumed stability of the curve. Consequently, the tradeoff between inflation and unemployment was understood to exist only in the short run.
Subsequent research has sought to reconcile these insights by incorporating expectations, productivity trends, and supply shocks into a more dynamic model. The modern interpretation treats the Phillips Curve not as a stable empirical law but as a conditional relationship whose slope and position shift over time. Thus, while the curve remains conceptually significant, its predictive and policy relevance have diminished as economists recognize the economy’s adaptive complexity.
Suppose a government launches an aggressive job-creation program at a time when businesses widely expect inflation to rise. According to the reasoning in the passage, which outcome would most likely follow?
A. A temporary fall in unemployment followed by renewed inflationary pressure
B. A long-term increase in employment as higher wages boost consumer demand
C. A jump in production costs that lifts inflation without delivering any lasting reduction in unemployment.
D. An increase in wages demanded by workers in the short run and sustained unemployment level drops
E. A brief but noticeable dip in unemployment that is later overshot, with joblessness rising above its starting level once firms pass higher costs on to consumers.
The phenomenon of stagflation in the 1970s- when high inflation coexisted with high unemployment- posed a direct challenge to this view. Economists such as Milton Friedman and Edmund Phelps argued that the original formulation neglected the role of expectations. If households and firms come to anticipate inflation, they adjust wages and prices accordingly, negating any sustained employment gains from expansionary policy. The oil shocks of that decade, which sharply increased production costs across industries, further illustrated how supply-side disturbances could simultaneously drive inflation and unemployment, undermining the presumed stability of the curve. Consequently, the tradeoff between inflation and unemployment was understood to exist only in the short run.
Subsequent research has sought to reconcile these insights by incorporating expectations, productivity trends, and supply shocks into a more dynamic model. The modern interpretation treats the Phillips Curve not as a stable empirical law but as a conditional relationship whose slope and position shift over time. Thus, while the curve remains conceptually significant, its predictive and policy relevance have diminished as economists recognize the economy’s adaptive complexity.
Suppose a government launches an aggressive job-creation program at a time when businesses widely expect inflation to rise. According to the reasoning in the passage, which outcome would most likely follow?
A. A temporary fall in unemployment followed by renewed inflationary pressure
B. A long-term increase in employment as higher wages boost consumer demand
C. A jump in production costs that lifts inflation without delivering any lasting reduction in unemployment.
D. An increase in wages demanded by workers in the short run and sustained unemployment level drops
E. A brief but noticeable dip in unemployment that is later overshot, with joblessness rising above its starting level once firms pass higher costs on to consumers.
10 Oct 2025, 22:09
Kudos
Bookmarks
Official Solution:
In the mid-twentieth century, economist A.W. Phillips identified a persistent inverse relationship between unemployment and inflation, suggesting that efforts to reduce joblessness tended to accelerate price increases. This empirical observation, later formalized as the Phillips Curve, appeared to provide policymakers with a manageable tradeoff: lower unemployment could be achieved at the expense of higher inflation, and vice versa. During the 1960s, this framework gained wide acceptance, informing expansionary fiscal and monetary strategies across several advanced economies.
The phenomenon of stagflation in the 1970s- when high inflation coexisted with high unemployment- posed a direct challenge to this view. Economists such as Milton Friedman and Edmund Phelps argued that the original formulation neglected the role of expectations. If households and firms come to anticipate inflation, they adjust wages and prices accordingly, negating any sustained employment gains from expansionary policy. The oil shocks of that decade, which sharply increased production costs across industries, further illustrated how supply-side disturbances could simultaneously drive inflation and unemployment, undermining the presumed stability of the curve. Consequently, the tradeoff between inflation and unemployment was understood to exist only in the short run.
Subsequent research has sought to reconcile these insights by incorporating expectations, productivity trends, and supply shocks into a more dynamic model. The modern interpretation treats the Phillips Curve not as a stable empirical law but as a conditional relationship whose slope and position shift over time. Thus, while the curve remains conceptually significant, its predictive and policy relevance have diminished as economists recognize the economy’s adaptive complexity.
Suppose a government launches an aggressive job-creation program at a time when businesses widely expect inflation to rise. According to the reasoning in the passage, which outcome would most likely follow?
A. A temporary fall in unemployment followed by renewed inflationary pressure
B. A long-term increase in employment as higher wages boost consumer demand
C. A jump in production costs that lifts inflation without delivering any lasting reduction in unemployment.
D. An increase in wages demanded by workers in the short run and sustained unemployment level drops
E. A brief but noticeable dip in unemployment that is later overshot, with joblessness rising above its starting level once firms pass higher costs on to consumers.
A) Correct Answer. The passage says that when expansionary policy meets pre-existing inflation expectations, wages and prices adjust quickly, which “negates any sustained employment gains.” Economists still allow for a short-run Phillips-curve effect before expectations fully feed through, so unemployment can dip briefly. Once wage and price hikes spread through the economy, inflation rises and the employment boost disappears. This sequence is exactly what option A describes: a temporary fall in unemployment followed by renewed inflationary pressure.
B) Incorrect. A lasting rise in employment contradicts the expectations-augmented Phillips Curve that Friedman and Phelps proposed. Because workers and firms anticipate higher inflation, their faster wage and price adjustments eliminate the initial jobs boost, preventing any long-term employment gain that higher consumer demand might otherwise bring.
C) Incorrect. The scenario here resembles the 1970s oil shocks, a supply-side story where production costs jump. In the question, the driver is an aggressive job-creation program, a demand-side policy. The passage links cost-push inflation to external supply disturbances, not to expansionary spending when inflation is already expected. Therefore this option does not follow the reasoning outlined.
D) Incorrect. Workers do demand higher wages when they expect inflation, yet the passage emphasizes that the resulting price and wage adjustments cancel the employment benefit. Predicting both higher wages and a sustained unemployment drop ignores this cancellation effect, so the option conflicts with the text.
E) Incorrect. The option adds an “overshoot,” claiming unemployment rises above its starting level once firms pass higher costs on to consumers. The passage never suggests expansionary policy leaves the labor market worse than before; it states only that any employment gain is wiped out, bringing unemployment back toward its original level. By predicting a rebound past the starting point, the option goes beyond the mechanism described and is therefore wrong, though it may tempt readers with its mention of a brief dip followed by inflation.
Answer: A
In the mid-twentieth century, economist A.W. Phillips identified a persistent inverse relationship between unemployment and inflation, suggesting that efforts to reduce joblessness tended to accelerate price increases. This empirical observation, later formalized as the Phillips Curve, appeared to provide policymakers with a manageable tradeoff: lower unemployment could be achieved at the expense of higher inflation, and vice versa. During the 1960s, this framework gained wide acceptance, informing expansionary fiscal and monetary strategies across several advanced economies.
The phenomenon of stagflation in the 1970s- when high inflation coexisted with high unemployment- posed a direct challenge to this view. Economists such as Milton Friedman and Edmund Phelps argued that the original formulation neglected the role of expectations. If households and firms come to anticipate inflation, they adjust wages and prices accordingly, negating any sustained employment gains from expansionary policy. The oil shocks of that decade, which sharply increased production costs across industries, further illustrated how supply-side disturbances could simultaneously drive inflation and unemployment, undermining the presumed stability of the curve. Consequently, the tradeoff between inflation and unemployment was understood to exist only in the short run.
Subsequent research has sought to reconcile these insights by incorporating expectations, productivity trends, and supply shocks into a more dynamic model. The modern interpretation treats the Phillips Curve not as a stable empirical law but as a conditional relationship whose slope and position shift over time. Thus, while the curve remains conceptually significant, its predictive and policy relevance have diminished as economists recognize the economy’s adaptive complexity.
Suppose a government launches an aggressive job-creation program at a time when businesses widely expect inflation to rise. According to the reasoning in the passage, which outcome would most likely follow?
A. A temporary fall in unemployment followed by renewed inflationary pressure
B. A long-term increase in employment as higher wages boost consumer demand
C. A jump in production costs that lifts inflation without delivering any lasting reduction in unemployment.
D. An increase in wages demanded by workers in the short run and sustained unemployment level drops
E. A brief but noticeable dip in unemployment that is later overshot, with joblessness rising above its starting level once firms pass higher costs on to consumers.
A) Correct Answer. The passage says that when expansionary policy meets pre-existing inflation expectations, wages and prices adjust quickly, which “negates any sustained employment gains.” Economists still allow for a short-run Phillips-curve effect before expectations fully feed through, so unemployment can dip briefly. Once wage and price hikes spread through the economy, inflation rises and the employment boost disappears. This sequence is exactly what option A describes: a temporary fall in unemployment followed by renewed inflationary pressure.
B) Incorrect. A lasting rise in employment contradicts the expectations-augmented Phillips Curve that Friedman and Phelps proposed. Because workers and firms anticipate higher inflation, their faster wage and price adjustments eliminate the initial jobs boost, preventing any long-term employment gain that higher consumer demand might otherwise bring.
C) Incorrect. The scenario here resembles the 1970s oil shocks, a supply-side story where production costs jump. In the question, the driver is an aggressive job-creation program, a demand-side policy. The passage links cost-push inflation to external supply disturbances, not to expansionary spending when inflation is already expected. Therefore this option does not follow the reasoning outlined.
D) Incorrect. Workers do demand higher wages when they expect inflation, yet the passage emphasizes that the resulting price and wage adjustments cancel the employment benefit. Predicting both higher wages and a sustained unemployment drop ignores this cancellation effect, so the option conflicts with the text.
E) Incorrect. The option adds an “overshoot,” claiming unemployment rises above its starting level once firms pass higher costs on to consumers. The passage never suggests expansionary policy leaves the labor market worse than before; it states only that any employment gain is wiped out, bringing unemployment back toward its original level. By predicting a rebound past the starting point, the option goes beyond the mechanism described and is therefore wrong, though it may tempt readers with its mention of a brief dip followed by inflation.
Answer: A
