Answer
a) Please see the first graph below. The current equilibrium between the long run and short run Phillips curve is labeled with point A.
b) With the wave of business pessimism, the economy is now at point B. (The unemployment rate increases, and the inflation rate falls.) If the Fed undertakes expansionary monetary policy, then aggregate demand will increase. The increased aggregate demand will offset the pessimism, and the economy will recover to the original equilibrium.
Work Step by Step
c) When the price of oil increases, the Phillips curve shifts to the right (from $PC_{SR_1}$ to $PC_{SR_2}$). Also, the economy moves from point A to point C (higher unemployment and higher inflation).
Should the Fed use expansionary monetary policy, then point D is possible. However, this would mean that inflation is higher when the unemployment rate stays constant. Should the Fed use contractionary monetary policy, then point C is possible. However, this would mean that unemployment is higher when the inflation rate stays the same.
This differs from part (b) in the fact that part (b) stayed on the same short run Phillips curve while part (c) is on a different short run Phillips curve.
