1. The unemployment rate in the country of Southland is greater than the natural rate of unemployment.
(a) Using a correctly labeled graph of aggregate demand and aggregate supply, show the current equilibrium
real gross domestic product, labeled YC, and price level in Southland, labeled PLC.
The president of Southland is receiving advice from two economic advisers—Kohelis and Raymond—about
how best to reduce unemployment in Southland.
(b) Kohelis advises the president to decrease personal income taxes.
(i) How would such a decrease in taxes affect aggregate demand? Explain.
(ii) Using a correctly labeled graph of the short-run Phillips curve, show the effect of the decrease in taxes.
Label the initial equilibrium from part (a) as point A, and the new equilibrium resulting from the
decrease in taxes as point B.
(c) Raymond advises the president to take no policy action.
(i) What will happen to the short-run aggregate supply curve in the long run? Explain.
(ii) Using a new correctly labeled graph of the short-run Phillips curve, show the effect of the change in
the short-run aggregate supply you identified in part (c)(i).
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