Unit 5 & 6

AD/AS

From Short Run to Long Run

• AS curve doesn't shift in response to changes in the AD curve in the short run
• Example:
• Nominal wages do not respond to price-level changes
• Workers may not realize impact of the changes on may be under contract
• Long run- Period in which nominal wages are fully responsive to previous changes in price level
• When changes occur in the short run they result in either increased or decreased producer profits- not changes in wages paid
• In the long run increases in AD result in a higher price level, as in the short run, but as worker demand more money the AS curve is going to shift left to equte production at the original output level, but now at a higher price
• In the long run, the AS curve is vertical at the natural rate of unemployment (NRU), or full employment (FE) level of output. Everyone wants a job has one and no one is enticed into or put out of the market
• Demand- Pull inflation will result when an increase in demand shifts the AD curve to the right, temporarily increasing output while raising prices
• Cost-Push inflation reselts when an increase in input costs that shifts the AS cure to the left. In this case, price level is not in response to the increase in AD, but instead the cause of PL increasing.

Phillips Curve

• It represents the relationship between unemployment and inflation
• The trade off between inflation and unemploymnent occurs over the short run
• Each point on the Phillips curve corresponds to a different level of output

LRPC- Long Run Phillips Curve

• Occurs at NRU
• Represented by a vertical line
• No trade off between unemployment and inflation in the long run
1. The economy produces at the full employment output level
2. Nominal wages of workers fuilly incorporates any chnages in price level as wages adjust to inflation over the long run
• LRPC only shifts if LRAS curve shifts
• LRAS and LRPC= same determinants
• Increases in unemployment will shift LRPC right
• Decreases in unemployment will shift LRPC left

Short Run Phillips Curve (SRPC)

• Shifts downward
• Increases in AD= Up and left
• Determinants are the same as AD graph
• Decrease in AD= Downward and right

Supply Shock

• A rapid and significant increase in resource cost which causes the SRAS curve to shift

Natural Rate of Unemployment

• Equal to frictional + structural + seasonal unemployment
• NOT cyclical
• The natural rates and fewer worker benefits create a lower NRU

Misery Index

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

• If the inflation rate persists and the expected rate of inflation rises, then the entire SRPC moves upward, so when that happens stagflation exists
• If inflation expectation drop (new technology and efficiency) then the SRPC moves downward.

Stagflation-Occurs when you have high unemployment and high inflation occuring at the same time

Disinflation

• When inflation decreases over time
• Nominal wages increase
• Business profits fall as prices are rising
• Firms reduce employment thus unemployment increases

Laffer Curve

• Is a trade off between tax rates and government revenue
• Tax rates increase from zero, tax revenue increase from zero to some maximum level and then decline
• The higher the tax rate you set, the less you collect
• Controversial and debatable

Criticisms of the Laffer Curve

1. Where the economy is located on the curve is difficult to determine
2. Tax cuts also increase demand which can fuel inflation
3. Empirical evidence suggests that the impact of tax rates on incentives to work, save, and incest are small

Supply Side Economics-Reganomics

• 80's
• They support policies that support GDP growth by arguing that high marginal tax rates along with the current system of transfer payments (unemployment compensation/ social security) provide disincentives to work, invest, innovate, and undertake entrepreneurial ventures
• Believe the AS curve will determine levels of inflation, unemployment, and economic growth
• Trickle down effect

Marginal Tax Rate

• The amount paid on the last dollar earned or on each additional dollar earned
• Supply side economics- If you reduce Marginal tax rate, more people would be inclined to work longer, thus forgoing leisure time for extra income.
  
  
  
  
  
  
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