Unit 5

Chapter 16. Extending the Analysis of Aggregate Supply

Short Run:

In macroeconomics, this is the period in which wage (and other inout prices) remain fixed as price level increase or decrease.

Long Run:

-period of time in which wages have become fully responsive to change in price level.

Effects in Short Run:

-In SR, price level changes allow for companies to exceed normal outputs and hire more workers because profits are increasing while wages remain constant

- In LR, wages will adjust to the price level and previous output level will adjust accordingly

Equilibrium in the Extended Model

Long aggregate supply curve is represented without vertical lone at full employment level of real GDP.

Demand Pull Inflation in the AS Model

• Demand-Pull: prices increase based on increase in AD
• SR, Demand pull will drive up prices and increase production
• Long run increases in aggregate demand will return to previous levels

Cost Push and Extended Model

Cost-push arises from factors that will increase per-unit costs such as increase in the price of a key resource

Dilemma for Government

• An effort to flight cost-push, the government can react in two different ways.
• Action such as spending by the government could begin an inflationary spinal
• No action however could lead to recession by keeping production and employment levels declining


The Phillips Curve

Long Run Phillips Curve

note: natural rate of unemployment is held constant

• Because the LRPC exists at the natural rate of unemployment (Un), structural changes in the economy that effect Un will also cause the LRPC to shift

•  Increase in Un will shift LRPC to the right
• Decrease in Un will shift LRPC to the left
• There is no trade-off between inflation and unemployment in the long run
• It occurs at the natural rate of unemployment
• It is represented by a vertical line
• LRPC will shift if the LRAS curve shifts

Short Run Phillips Curve

    

• There is a trade-off between inflation and unemployment
• When one goes up the other goes down. (inverse)

Supply Shocks 

• A rapid and significant increase in resourse cost which causes SRAS curve to shift
• SRAS most likely to shift left and SRPC to shift right

Misery Index

• The combination of inflation and unemployment in any given year
• Single digit misery is good