ECON 330: Money and Banking HW 14 Solution

Transcription

1 ECON 330: Money and Banking HW 14 Solution Based on Steven Zhang, edited by Alan Yang 22.5 As labor productivity grows, the long-run aggregate supply curve shifts to the right. This is because the existing labor force, along with a given amount of capital and other resources, can produce more output, indicating a greater amount of potential output Shifts in the short-run aggregate supply curve result from changes in expected inflation, price shocks, and persistent output gaps. None of these factors shift the long-run aggregate supply curve because price and wage flexibility ensures that in the long run the economy produces at its potential output level. Potential output depends not on actual or expected inflation but rather on the capital, labor, and technology available for producing goods and services. However, a change in potential output shifts the long-run aggregate supply curve and also the short-run aggregate supply curve because it changes the output gap at any given level of actual output When output is less than potential output, unemployment is above the natural rate and labor market slack causes wages to rise less rapidly. As the Phillips curve suggests, this causes firms to raise their prices less rapidly and thus decreases the inflation rate. As a result, expected inflation will be lower in the following time period and the short-run aggregate supply curve will shift downward. This adjustment process in which inflation and expected inflation fall and the short-run aggregate supply curve shifts downward continues over time until output increases to the potential output level, the output gap increases to zero, and the economy reaches long-run equilibrium When the unemployment rate is above the natural rate of unemployment, there is slack in the labor market and output is below potential. This causes the short-run aggregate supply curve to shift downward, leading to lower inflation and higher output over time, until the economy reaches a long-run equilibrium. 1

2 22.14 An increase in government spending will lead to a rightward shift of the aggregate demand curve. In the short run, inflation and output will both rise. This leads to tightness in the labor market, which raises inflation expectations and shifts the short-run aggregate supply curve up; as this occurs, the economy moves to a new long-run equilibrium, output falls back to potential, and inflation increases Technological change and infrastructure improvements affect the long-run aggregate supply curve. More fuel-efficient cars result in a decrease in the demand for gas at the same time that innovations in energy production make it possible to increase the supply of energy at any price level. Innovations in these fields result in a shift to the right in both the short- and long-run supply curves. Improvements in infrastructure make transportation of goods to market more efficient, and raise productivity in a variety of ways. In conclusion, inflation decreases and output increases in the long run In order for the unemployment rate to rise and inflation to remain constant, both the aggregate supply and demand curves would have to shift to the left. If they shift horizontally to the left by the same amount, the result is inflation remaining the same, but output falling and the unemployment rising in the short run, as shown in the graph below. 2

3 22.24 (a) Negative demand shock. An increase in financial frictions reduces aggregate demand. Output and inflation fall in the short run; in the long run, output rises back to potential, and inflation falls. (b) Positive demand shock. This increases autonomous consumption and investment, which increases aggregate demand. Output and inflation increase in the short run; in the long run, output falls back to potential, and inflation increases. 3

4 (c) Positive (temporary) supply shock. This shifts the short-run aggregate supply curve to the right (down). Output increases and inflation decreases in the short run; in the long run, output falls back to potential, and inflation increases, returning to the original level. (d) Negative (temporary) supply shock. This shifts the short-run aggregate supply curve to the left (up). Output decreases and inflation increases in the short run; in the long run, output increases back to potential, and inflation decreases, returning to the original level. 4

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