Post on 12-May-2015
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Extending the Analysis ofAggregate Supply
16C H A P T E R
SHORT-RUN AND LONG-RUNAGGREGATE SUPPLY
Period in which nominal wages (and other input prices) remainfixed as the price level increases or decreases
Short Run -
Period in which nominal wages are fully responsive to previous changes in the price level
Long Run -
o
AS1
P1
P2
Qf Q2
a1
a2
A higher price level increases profits and output moving the economy from a1 to a2.
Pri
ce L
evel
Real domestic output
SHORT-RUN AGGREGATE SUPPLY
o
AS1
P1
P2
Qf
a1
a2
A lower price level decreases profits and output moving the economy from a1 to a3 .
Pri
ce L
evel
Real domestic output
SHORT-RUN AGGREGATE SUPPLY
P3 a3
Q2Q3
o
AS1
P1
P2
Qf
a2
a1
AS2
b1
ASLRP
rice
Lev
el
Real domestic output
LONG-RUN AGGREGATE SUPPLYA higher price level results in higher nominal wages and thus shifts the short-run aggregate supply to the left .
o
P3
AS1
P1
P2
Qf
a2
a3
a1
AS2
b1
AS3
c1
ASLRP
rice
Lev
el
Real domestic output
LONG-RUN AGGREGATE SUPPLYA lower price level results reduces nominal wages and shifts the short-run aggregate supply to the right .
EQUILIBRIUM IN THEEXTENDED AD-AS MODEL
o
P1
AS1
ASLR
AD1
a
Qf
Pri
ce L
evel
Real domestic output
DEMAND-PULL INFLATION
o
P1
AS1
ASLR
AD1
a
Qf
Pri
ce L
evel
Real domestic output
bP2
P3
AD2
AS2
c
Q1
Q2
COST-PUSH INFLATION
o
P1
AS1
ASLR
AD1
a
Qf
Pri
ce L
evel
Real domestic output
bP2
AS2
Occurs when short-run AS shifts left
Q2
COST-PUSH INFLATION
o
P1
AS1
ASLR
AD1
a
Qf
Pri
ce L
evel
Real domestic output
bP2
P3
AD2
AS2
Government response with increased AD
c
Evenhigherpricelevels
COST-PUSH INFLATION
o
P1
AS1
ASLR
AD1
a
Qf
Pri
ce L
evel
Real domestic output
bP2
AS2
If government allows a recession to occur
Q2
Q2
COST-PUSH INFLATION
o
P1
AS1
ASLR
AD1
a
Qf
Pri
ce L
evel
Real domestic output
bP2
AS2
If government allows a recession to occur
Nominal wages fall &AS returns
to its originallocation
THE INFLATION-UNEMPLOYMENTRELATIONSHIP
• Normally, there is a short-run trade-off between the rate of inflation and the the rate of unemployment.
• Aggregate supply shocks can cause both higher rates of inflation and higher rates of unemployment.
• There is no significant trade-off over long periods of time.
o
P0
Q0
AD0
AS
EFFECT OF CHANGES IN AGGREGATE DEMANDON REAL OUTPUT AND THE PRICE LEVEL
Pri
ce L
evel
Real domestic output
o
P0
P1
Q0 Q1
AD0 AD1
AS
EFFECT OF CHANGES IN AGGREGATE DEMANDON REAL OUTPUT AND THE PRICE LEVEL
Pri
ce L
evel
Real domestic output
o
P0
P1
P2
Q0 Q1 Q2
AD0 AD1 AD2
AS
EFFECT OF CHANGES IN AGGREGATE DEMANDON REAL OUTPUT AND THE PRICE LEVEL
Pri
ce L
evel
Real domestic output
o
P0
P1
P2
P3
Q0 Q1 Q2 Q3
AD0 AD1 AD2 AD3
AS
EFFECT OF CHANGES IN AGGREGATE DEMANDON REAL OUTPUT AND THE PRICE LEVEL
Pri
ce L
evel
Real domestic output
An
nu
al r
ate
of in
flat
ion
(per
cen
t)
Unemployment rate (percent)
7
6
5
4
3
2
1
01 2 3 4 5 6 7
As inflation declines...
THE PHILLIPS CURVE CONCEPT
unemploymentincreases
1997
15
10
5
01992 2002
U.K.
GLOBAL PERSPECTIVEThe Misery Index, Selected Nations 1992 - 2002
Source: Bureau of Labor Statistics
Canada
Italy
France
U.S.
Germany
Japan
THE LONG-RUN PHILLIPS CURVE
Aggregate-Supply Shocks
Stagflation’s Demise
Short-Run Phillips Curve
Long-Run Vertical Phillips Curve
Disinflation
TAXATION AND AGGREGATE SUPPLY
Supply-Side Economics
Taxes and Incentives to Work
Incentives to Save and Invest
Laffer Curve
0
100
l
THE LAFFER CURVE
Tax revenue (dollars)
Tax
rat
e (p
erce
nt)
0
100
m
l
THE LAFFER CURVE
Tax revenue (dollars)
Tax
rat
e (p
erce
nt)
0
100
m
n
l
THE LAFFER CURVE
Tax revenue (dollars)
Tax
rat
e (p
erce
nt)
0
100
m m
n
l
THE LAFFER CURVE
Tax revenue (dollars)
Tax
rat
e (p
erce
nt)
MaximumTax
Revenue
Criticisms of the Laffer Curve
Taxes, Incentives, and Time
Inflation or Higher Interest Rates
Position on the CurveRebuttal and Evaluation
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Economic Growth
Chapter 17