Extending the Analysis of Aggregate Supply
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1 35 Extending the Analysis of Aggregate Supply McGraw-Hill/Irwin Copyright 2012 by The McGraw-Hill Companies, Inc. All rights reserved.
2 AGENDA Thurs 3/3 Team Teaching: CH 35 (Wrap-up??) P3: Grant, Hannah, Jason, Pedro P5: Ms. K (still) QOD #20: East Compton Practice/Review Handouts On Deck: CH 30 (Thurs) P3: Amanda, Jeyla, Joseph, Vanessa P5: Ms. K (yep, once again) HW: Prep for CH 28, 29, 35 Assessment (Tues) Read pp Q#2,3 P#1 LO1 29-2
3 QOD #20: East Compton Suppose that for years East Compton s short-run Phillips Curve was such that each 1 percentage point increase in its unemployment rate was associated with a 2 percentage point decline in its inflation rate. Then, during several recent years, the short-run pattern changed such that its inflation rate rose by 3 percentage points for every 1 percentage point drop in its unemployment rate. Graphically, did East Compton s Phillips Curve shift upward or did it shift downward? LO1 29-3
4 QOD #20: East Compton The Phillips Curve shifted upward. This occurs in response to a decrease in the aggregate supply curve. LO1 29-4
5 FRQ Practice 2012 #3 (SRAS/LRAS-wages) Solution 2013 #3 (Phillips Curve) Solution 2011 #1a,b,c (SRPC/LRPC) Solution 2988
6 From Short Run to Long Run Short run Input prices inflexible Upsloping aggregate supply Long run Input prices fully flexible Vertical aggregate supply The transition? LO1 35-6
7 From Short Run to Long Run Production above potential output: High demand for inputs Input prices rise so Short run aggregate supply shifts left Return to potential output Production below potential output- input prices fall (assuming wages are flexible downward) Graphical examples LO1 35-7
8 Price Level Price Level From Short Run to Long Run Short-Run Aggregate Supply Long-Run Aggregate Supply P 2 a 2 AS 1 P 2 AS LR b 1 AS 2 AS 1 AS 3 a 2 P 1 a 1 P 1 a 1 P 3 a 3 P 3 a 3 c 1 Q 3 Q f Q 2 Q f Real Domestic Output Real Domestic Output LO1 35-8
9 Price Level From Short Run to Long Run Long Run Equilibrium AS LR AS 1 P 1 a AD 1 Q f Real Domestic Output LO1 35-9
10 Price Level Extended AD-AS Model Demand-Pull Inflation- Where do workers come from? AS LR AS 2 AS 1 P 3 P 2 P 1 c a b AD 1 AD 2 Q f Q 2 Real Domestic Output LO
11 Price Level Extended AD-AS Model Cost-Push Inflation- Policy Dilemna? AS LR AS 2 AS 1 P 3 P 2 P 1 b c a AD 1 AD 2 Q 2 Q f Real Domestic Output LO
12 Price Level Extended AD-AS Model Recession AS LR AS 1 AS 2 P 1 P 2 P 3 b a c AD 1 AD 2 Q 1 Q f Real Domestic Output LO
13 Extended AD-AS Model Explaining ongoing inflation Ongoing economic growth shifts aggregate supply Ongoing increases in money supply shift aggregate demand Small positive rate of inflation See p.724. LO
14 Capital Goods Price Level Economic Growth, Ongoing Inflation Productions Possibilities Long Run Aggregate Supply Consumer Goods Increase in production possibilities Real GDP Increase in long-run aggregate supply LO
15 Inflation and Unemployment Low inflation and unemployment Fed s major goals Compatible or conflicting? See p Short-run tradeoff Supply shocks cause both rates to rise No long-run tradeoff LO
16 The Phillips Curve 1960s economists believed in stable, predictable tradeoff Phillips curve shifts over time- more inflation and unemployment Adverse supply shocks 1970s OPEC oil price shock Stagflation Stagflation s demise 1980s-Fed raised interest rates to combat inflation. This helped to lead to recession in the early 1980s. See p.727. LO
17 The Phillips Curve No long-run tradeoff between inflation and unemployment Short-run Phillips curve Role of expected inflation Long-run vertical Phillips curve-see diagram Disinflation LO
18 Annual rate of inflation (percent) The Phillips Curve Unemployment rate (percent) LO
19 Tax Rate (Percent) Taxes and Aggregate Supply Supply-side economics Tax incentives to work Tax incentives to save and invest The Laffer curve 100 n Laffer Curve m m l Maximum Tax Revenue LO5 0 Tax Revenue (Dollars) 35-19
20 Taxes and Aggregate Supply Criticisms of the Laffer curve Taxes, incentives, and time- no real increase in incentive- some people will see they have more after-tax money and work LESS hard. Inflation and higher real interest rates- if AD is at or near full-employment then it is likely to see inflation. Position on the curve- where the economy is on the curve is significant if you even agree with the curve Rebuttal and evaluation-cutting taxes lead to higher revenues. PROBLEM: if you don t cut spending, then you will have HUGE deficits with huge tax cuts(i.e. under Reagan and G.W. Bush). LO
Extending the Analysis of Aggregate Supply
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