Unit 5-6

April 7,2016

Unit 5-6

In macroeconomics this is the period in which wages (and other input prices) remain fixed as price level increases or decreases

Effects over short run

• in the short run price level changes allow for companies to exceed normal outputs and hire more workers because profits are increasing while wages remain constant 
• in the long run wages will adjust to the price level and previous output levels will adjust accordingly 

Equilibrium in the extended model

• the long as curve is represented with a vertical line @ full employment level of real GDP 

Demand pull inflation in the AS model

• demand pull prices increase based on increase in aggregate demand 
• In the short run demand pull will drive up prices and increase production 
• In the long run, increases in aggregate demand will eventually return to previous levels 

Cost push and the 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 the government

• in an effort to fight cost push the government can react in two different ways 
• Action such as spending by the gov. Could begin an inflationary spiral 
• No action however could lead to recession by keeping production and employment levels declining 

The long run Phillips curve 

Note: natural rate of unemployment 

Because the long run Phillips curve exists at the natural rate of unemployment (Un) structural changes in the economy that affect Un will also cause the LRPC to shift 

• increase in Un will shift the LRPC➡️
• Decreases in Un will shift LRPC⬅️

Long run Phillips curve

- no trade off between inflation and unemployment at LRPC

- Always vertical at the natural rate of unemployment

- Only shift if LRAS shifts

Natural rate of unemployment(4-5%) =frictional +structural+seasonal unemployment

The major LRPC assumption is that more worker benefits creat higher natural rates and fewer worker benefits creates lower natural rates

SRPC

- same as short run

Supply shocks

- rapid and significant increases in resource cost which causes the SRAS curve to shift

- SRAS is going to decrease

- SRPC is going to shift outward (increasing)

Misery index

- combination of inflation and unemployment in any given year

- Single digit misery is good

Inflation: General rate in the price level.

Deflation:General decline in price level.

Disinflation:Reduction in the inflation rate from year to year.

Stagflation: unemployment and inflation increase at the same time. 

• Changes in AS but not AD
• Determines the level of inflation, unemployment rates, and economic growth.
• Supply Side economists support policies that promote GDP growth that arguing that high marginal tax rates along with the current system of transfer payments provide disincentives to work, invest, innovate, and undertake entrepreneurial ventures.

Incentive to save and invest

1. Higher marginal tax rates reduce the rewards for savings and investment.
2. Consumption might increase but investment depends upon savings.
3. Lower marginal tax rates encourage saving and investment.

Laffer Curve

• There is a theoretical relationship between tax rates and Govt. revenue. 
• As tax rates increase from 0, Govt. Revenue increase from 0 to max level but then decline.

Criticism of Laffer Curve

• Research suggests that the impact of tax rates on incentives to work, save, and invest is small. 
• Tax cuts also increase demand which fuels inflation and causes demand to exceed supply. 
• Where the economy is located on the curve is difficult to determine.