Module M16 Quiz: The Labour Market and Phillips Curve

30 questions · Intermediate · Mix of multiple choice, calculation, and short answer

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Attempt each question before clicking Show Answer. For calculation questions, write out your working before checking.

Question 1

Lesson L01 · Unemployment

The wage-setting curve shows real wages as a function of:

Type: Multiple Choice

A) Inflation only
B) Unemployment — higher unemployment lowers real wages workers can negotiate
C) Interest rates
D) Government spending

Show Answer

Answer: B) Unemployment — higher unemployment lowers real wages workers can negotiate

With high unemployment workers have less bargaining power pushing real wages down.

Question 2

Lesson L01 · Inflation

The price-setting curve gives real wages as:

Type: Multiple Choice

A) A positive function of unemployment
B) A constant determined by firm markup μ: W/P = 1/(1+μ)
C) A function of inflation expectations
D) A rising function of output

Show Answer

Answer: B) A constant determined by firm markup μ: W/P = 1/(1+μ)

Firms set prices as markup over wages: P=(1+μ)W so real wage W/P=1/(1+μ) — independent of u.

Question 3

Lesson L01 · Inflation

If markup μ=0.25 what real wage does the price-setting curve imply?

Type: Calculation

Show Answer

Answer: 0.80

W/P = 1/(1+0.25) = 1/1.25 = 0.80

Question 4

Lesson L01 · Unemployment

Explain how the NAIRU is determined using the wage-setting and price-setting curves.

Type: Short Answer

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Answer: NAIRU is the unemployment rate where the wage-setting curve intersects the price-setting curve — where workers' wage demands are consistent with firms' pricing decisions.

At NAIRU real wage aspirations and real wage outcomes are mutually consistent with stable inflation.

Question 5

Lesson L01 · Unemployment

An increase in unemployment benefits shifts the wage-setting curve:

Type: Multiple Choice

A) Down (lower wages at any u)
B) Up (higher wages at any u)
C) It has no effect
D) It flattens the curve

Show Answer

Answer: B) Up (higher wages at any u)

Higher unemployment benefits raise workers' reservation wage shifting the WS curve up → NAIRU rises.

Question 6

Lesson L02 · Unemployment

NAIRU is defined as the unemployment rate at which:

Type: Multiple Choice

A) GDP is maximised
B) Inflation is at its target
C) Inflation is stable (neither rising nor falling)
D) The output gap is positive

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Answer: C) Inflation is stable (neither rising nor falling)

At NAIRU there is no cyclical pressure on wages or prices so inflation remains constant.

Question 7

Lesson L02 · Unemployment

Australia's RBA estimated post-COVID NAIRU at approximately:

Type: Multiple Choice

A) 2-2.5%
B) 3-3.5%
C) 4-4.25%
D) 5-5.5%

Show Answer

Answer: C) 4-4.25%

RBA's post-COVID estimates place u* around 4.0-4.25% reflecting structural labour market changes.

Question 8

Lesson L02 · Unemployment

If structural unemployment=2.5% and frictional unemployment=1.5% what is NAIRU?

Type: Calculation

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Answer: 4.0%

NAIRU = frictional + structural = 2.5% + 1.5% = 4.0%

Question 9

Lesson L02 · Unemployment

How does technological disruption affect NAIRU?

Type: Short Answer

Show Answer

Answer: It raises structural unemployment (workers whose skills are obsolete must retrain) increasing NAIRU unless offset by active labour market policies.

Structural displacement from technology shifts the wage-setting curve reducing equilibrium employment.

Question 10

Lesson L02 · Unemployment

Australia's unemployment reached 3.5% in January 2023 — below NAIRU. What does this imply?

Type: Multiple Choice

A) Deflation
B) Accelerating wage and price inflation as labour market is tighter than the natural rate
C) Zero inflation
D) Monetary policy should ease

Show Answer

Answer: B) Accelerating wage and price inflation as labour market is tighter than the natural rate

Below NAIRU unemployment firms compete for scarce labour pushing wages and eventually prices higher.

Question 11

Lesson L03 · Inflation

A.W. Phillips (1958) found a stable empirical relationship between:

Type: Multiple Choice

A) Inflation and GDP growth
B) Nominal wage growth and unemployment in UK data 1861-1957
C) Real wages and employment
D) Interest rates and output

Show Answer

Answer: B) Nominal wage growth and unemployment in UK data 1861-1957

Phillips documented the inverse relationship between wage inflation and unemployment over nearly 100 years of UK data.

Question 12

Lesson L03 · Inflation

Using the simple PC π = -0.6(u - u_n) with u_n=4% if u=6% what is inflation?

Type: Calculation

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Answer: -1.2%

-0.6×(6-4) = -0.6×2 = -1.2% (deflationary pressure)

Question 13

Lesson L03 · Inflation

The original Phillips curve collapsed during the 1970s stagflation because:

Type: Multiple Choice

A) It was never empirically valid
B) Oil price shocks shifted the curve outward — high unemployment AND high inflation coexisted
C) Governments stopped collecting data
D) Unemployment was mismeasured

Show Answer

Answer: B) Oil price shocks shifted the curve outward — high unemployment AND high inflation coexisted

Supply shocks can shift the PC so that both inflation and unemployment rise simultaneously.

Question 14

Lesson L03 · Inflation

What is the slope of the Phillips curve and what does it measure?

Type: Short Answer

Show Answer

Answer: The slope measures how much inflation changes per percentage point change in unemployment — steeper slope means stronger inflation-unemployment trade-off.

A flatter PC means larger unemployment changes are needed to reduce inflation by 1pp.

Question 15

Lesson L03 · Inflation

In the long run the Phillips curve is:

Type: Multiple Choice

A) Downward sloping — trade-off persists
B) Vertical at NAIRU — no permanent trade-off
C) Horizontal
D) Upward sloping

Show Answer

Answer: B) Vertical at NAIRU — no permanent trade-off

In the long run inflation expectations adjust fully so the PC is vertical — there is no permanent output-inflation trade-off.

Question 16

Lesson L04 · Inflation

The expectations-augmented Phillips curve (Friedman-Phelps) adds expected inflation to the original curve because:

Type: Multiple Choice

A) Central banks need to forecast inflation
B) Workers bargain for wages based on expected real wages — nominal wage growth reflects inflation expectations
C) Higher expectations always cause higher inflation
D) The RBA targets expectations

Show Answer

Answer: B) Workers bargain for wages based on expected real wages — nominal wage growth reflects inflation expectations

Workers and firms incorporate inflation expectations into wage/price setting so actual inflation = expected + demand pressure.

Question 17

Lesson L04 · Inflation

With EAPC π = π_e + 0.5(u_n - u) if π_e=3% u_n=4% u=3% what is π?

Type: Calculation

Show Answer

Answer: 3.5%

π = 3% + 0.5×(4-3) = 3% + 0.5% = 3.5%

Question 18

Lesson L04 · Unemployment

According to Friedman-Phelps monetary policy cannot permanently reduce unemployment below NAIRU because:

Type: Multiple Choice

A) Workers are irrational
B) Workers eventually revise up inflation expectations eliminating the real wage surprise that made hiring profitable
C) Central banks lack tools
D) Government spending offsets monetary policy

Show Answer

Answer: B) Workers eventually revise up inflation expectations eliminating the real wage surprise that made hiring profitable

Any temporary reduction in u below u_n triggers rising inflation until workers' expectations catch up.

Question 19

Lesson L04 · Inflation

What is the difference between adaptive and rational expectations?

Type: Short Answer

Show Answer

Answer: Adaptive expectations: agents update based on past inflation (backward-looking). Rational expectations: agents use all available information including the model itself (forward-looking).

Under rational expectations systematic monetary policy has no real effects even in the short run.

Question 20

Lesson L04 · Inflation

Credible disinflation under rational expectations is:

Type: Multiple Choice

A) More costly in output than adaptive expectations disinflation
B) Less costly — if credible agents immediately lower expectations reducing the output sacrifice
C) Equally costly in both cases
D) Always leads to recession

Show Answer

Answer: B) Less costly — if credible agents immediately lower expectations reducing the output sacrifice

With rational expectations a credible announced disinflation allows expectations to fall immediately minimising the output sacrifice.

Question 21

Lesson L05 · Inflation

An adverse supply shock (oil price rise) shifts the Phillips curve:

Type: Multiple Choice

A) Down — inflation falls
B) Right/up — higher inflation at any given unemployment rate
C) Left — unemployment falls
D) Vertically — no effect

Show Answer

Answer: B) Right/up — higher inflation at any given unemployment rate

Cost-push inflation from an oil shock raises firms' costs shifting the PC up so any u gives higher π.

Question 22

Lesson L05 · Inflation

Using PC π = π_e + 0.5(u_n - u) if a supply shock raises π_e from 2% to 5% and u=u_n what is π?

Type: Calculation

Show Answer

Answer: 5%

π = 5% + 0.5×(u_n - u_n) = 5% + 0 = 5%

Question 23

Lesson L05 · Inflation

Stagflation describes:

Type: Multiple Choice

A) High inflation with high growth
B) High inflation combined with high unemployment (stagnation + inflation)
C) Low inflation with low unemployment
D) Deflation with low unemployment

Show Answer

Answer: B) High inflation combined with high unemployment (stagnation + inflation)

Stagflation emerged in the 1970s as oil shocks pushed both inflation and unemployment higher simultaneously.

Question 24

Lesson L05 · Inflation

Why does a supply shock put central banks in a dilemma?

Type: Short Answer

Show Answer

Answer: Tightening to fight inflation worsens the recession; easing to support output worsens inflation — the central bank cannot simultaneously achieve both objectives.

Supply shocks move inflation and output in opposite directions forcing a trade-off.

Question 25

Lesson L05 · Monetary Policy

The RBA's preferred strategy during the 2022 supply-driven inflation was to:

Type: Multiple Choice

A) Ignore supply shocks and hold rates
B) Tighten aggressively to immediately return inflation to target regardless of output cost
C) Tighten gradually aiming to bring inflation back to target while preserving the labour market gains
D) Cut rates to support growth

Show Answer

Answer: C) Tighten gradually aiming to bring inflation back to target while preserving the labour market gains

The RBA adopted a 'narrow path' strategy — gradual tightening to avoid unnecessary unemployment.

Question 26

Lesson L06 · Inflation

Australia's WPI (Wage Price Index) growth rose from 1.9% (2020) to approximately:

Type: Multiple Choice

A) 2.5%
B) 3.0%
C) 4.2%
D) 5.5%

Show Answer

Answer: C) 4.2%

WPI reached 4.2% in 2023 the highest since 2009 reflecting the tight labour market post-COVID.

Question 27

Lesson L06 · Inflation

Australia's unemployment trough was 3.5% in January 2023. With NAIRU=4.25% and PC slope 0.5 what is the implied inflation pressure?

Type: Calculation

Show Answer

Answer: +0.375pp

π excess = 0.5×(4.25 - 3.5) = 0.5×0.75 = +0.375pp above baseline inflation

Question 28

Lesson L06 · Inflation

The Australian PC appears flatter post-1990s compared to the 1970s-80s. What explains this?

Type: Multiple Choice

A) Lower productivity growth
B) Better anchored inflation expectations from RBA inflation targeting reducing the inflation response to labour market tightness
C) More immigration
D) Less union membership

Show Answer

Answer: B) Better anchored inflation expectations from RBA inflation targeting reducing the inflation response to labour market tightness

Credible inflation targeting anchors expectations so that labour market tightness translates less into inflation.

Question 29

Lesson L06 · Inflation

CPI peaked at 7.8% in Q4 2022. Using the EAPC explain why this exceeded the RBA's 2-3% target band.

Type: Short Answer

Show Answer

Answer: Supply shocks (energy costs post-Ukraine war and supply chain disruptions) plus demand-pull pressure from fiscal stimulus overhang and tight labour market combined to shift the PC well above the RBA's target.

Both PC shift (supply shock) and movement along the PC (low u) contributed.

Question 30

Lesson L06 · Monetary Policy

The RBA raised the cash rate 13 times from 0.10% to 4.35% (2022-23). In the EAPC framework this works by:

Type: Multiple Choice

A) Directly reducing inflation expectations
B) Raising u toward and above NAIRU reducing the (u_n-u) term and moving down the PC
C) Shifting the PC downward
D) Increasing potential output

Show Answer

Answer: B) Raising u toward and above NAIRU reducing the (u_n-u) term and moving down the PC

Higher rates slow demand raising unemployment toward NAIRU reducing demand-pull inflation pressure.