ECO LECTURE TWENTY-FOUR 1 OKAY. WELL, WE WANT TO CONTINUE OUR DISCUSSION THAT WE HAD

Transcription

1 ECO LECTURE TWENTY-FOUR 1 OKAY. WELL, WE WANT TO CONTINUE OUR DISCUSSION THAT WE HAD STARTED LAST TIME. WE SHOULD FINISH THAT UP TODAY. WE WANT TO TALK ABOUT THE ECONOMY'S LONG-RUN EQUILIBRIUM SITUATION. LET ME JUST DO A LITTLE BIT OF REVIEW HERE SO THAT YOU'LL RECALL WHAT WE TALKED ABOUT LAST TIME. THIS STUFF HAS EVAPORATED ABOUT AS FAST AS I CAN GET IT ON THERE. THIS IS OUR ORIGINAL EQUILIBRIUM SITUATION AND WE'VE GOT A SHORT-RUN AGGREGATE SUPPLY CURVE. THE EXAMPLE WE TALKED ABOUT LAST TIME IS WE SAID SUPPOSE THAT NATURAL REAL GDP IS -- WHERE'D I PUT IT? -- RIGHT HERE, QN. AND IF YOU'LL REMEMBER, NATURAL REAL GDP IS EQUAL TO GDP -- OR REAL GDP AT FULL EMPLOYMENT. AND FULL EMPLOYMENT MEANS THAT UNEMPLOYMENT RATE IS EQUAL TO THE NATURAL RATE OF UNEMPLOYMENT. WHICH IS -- IF YOU'LL REMEMBER THE FRICTIONAL RATE PLUS THIS STRUCTURAL UNEMPLOYMENT RATE. NO CYCLICAL UNEMPLOYMENT OR MACROECONOMIC UNEMPLOYMENT. OKAY. SO WHAT -- AND WE'VE GOT THIS THING DOWN HERE WITH THE UNEMPLOYMENT. YOU REMEMBER WE HAD THAT OTHER AXIS, WE'RE MEASURING UNEMPLOYMENT, AND SOME PLACE BACK HERE IT'S ZERO. BUT ANYWAY, WE WOULD COME ACROSS HERE AND IF -- JUST TO PICK OUT A NUMBER, IF THE NATURAL RATE OF UNEMPLOYMENT IS FIVE PERCENT, FOR EXAMPLE, THEN WE'VE GOT A FIVE PERCENT UNEMPLOYMENT RATE WHICH

2 ECO LECTURE TWENTY-FOUR 2 CORRESPONDS TO NATURAL REAL GDP. AND SO WE SEE THIS IS FULL EMPLOYMENT, THE FULL EMPLOYMENT SITUATION. HOWEVER, THE ECONOMY HAS ALREADY REACHED AN EQUILIBRIUM AT A SMALLER LEVEL OF REAL GDP. SO WE SAID, OH, IF THE ECONOMY'S IN EQUILIBRIUM AT A SMALLER LEVEL OF REAL GDP, THEN THE NATURAL RATE, NATURAL REAL GDP, THEN WHAT WE HAVE IS WHAT? A HIGH UNEMPLOYMENT RATE, HIGHER THAN FIVE PERCENT. OKAY. RIGHT HERE IS SEVEN, EIGHT PERCENT, WHATEVER. WE'VE GOT A HIGH UNEMPLOYMENT RATE AND WE USE A TERM HERE. WE SAY THE ECONOMY'S IN A RECESSIONARY GAP. WHAT WE SAID WOULD HAPPEN IS THIS: IF THE ECONOMY'S IN A RECESSIONARY GAP, EVENTUALLY -- IT DOESN'T HAPPEN OVERNIGHT, BUT EVENTUALLY THE HIGH UNEMPLOYMENT RATE WILL CAUSE WORKERS TO -- UNEMPLOYED WORKERS TO START GOING IN AND SAYING, "HEY, I'D BE WILLING TO WORK FOR A LITTLE BIT LOWER WAGE. PLEASE HIRE ME." THERE'S A LOT OF COMPETITION FOR EACH JOB ALONG UNEMPLOYMENT LINES AND SO FORTH, AND SO WAGES START TO GO DOWN. AND AS WAGES START TO GO DOWN, WHAT HAPPENS IS THE AGGREGATE SUPPLY CURVE SHIFTS TO THE RIGHT. THIS IS DRAWN FOR A WAGE OF W1 -- AND LET'S JUST LET THAT BE, I DON'T KNOW, TWELVE DOLLARS AN HOUR FOR THE TYPICAL INDUSTRIAL WORKER, LET'S SAY. NON-MANAGEMENT WORKER. AND WHAT I'M SAYING IS, THE HIGH UNEMPLOYMENT RATE AT OUR

3 ECO LECTURE TWENTY-FOUR 3 FIRST LEVEL OF GDP, THAT HIGH UNEMPLOYMENT RATE CAUSES WAGES TO BE BID DOWN AND THEY GO DOWN AND DOWN AND DOWN, AND FINALLY THEY'RE BID DOWN TO -- LET'S SAY THE WAGE RATE EQUALS W2 EQUALS, I DON'T KNOW, TEN DOLLARS AN HOUR. THAT'S JUST SOMETHING I PULLED OUT OF THE AIR. BUT THE POINT IS, WHEN THE WAGE RATE HAS SHIFTED -- HAS DECREASED BY THAT MUCH, THE AGGREGATE SUPPLY CURVE WILL GET SHIFTED WAY OVER HERE TO THE RIGHT AND WE GET A NEW EQUILIBRIUM FOR THE ECONOMY, A NEW SHORT-RUN EQUILIBRIUM. WE'VE GOT A LOWER PRICE LEVEL AND OUR REAL GDP IS NOW EQUAL TO THE NATURAL REAL GDP, AND THE UNEMPLOYMENT RATE IS NOW FIVE PERCENT. AND SO NOW THAT THE UNEMPLOYMENT RATE'S GONE DOWN TO THIS NATURAL LEVEL, THEN THE PRESSURE ON WAGES TO CONTINUE FALLING, THAT PRESSURE IS GONE. THERE'S NO FURTHER DECREASE IN WAGES SO THERE'S NO FURTHER RIGHTWARD SHIFT IN THE AGGREGATE SUPPLY CURVE. IT STAYS WHERE WE'VE PUT IT THERE. WE WENT FROM AN EQUILIBRIUM OF POINT A TO A NEW EQUILIBRIUM OF POINT B. AND THE WHOLE POINT OF THIS IS: WHEN THE ECONOMY IS IN A RECESSIONARY GAP, EVEN IN THE ABSENCE OF ANY POLICY TO DO ANYTHING, THE PRIVATE MARKET ECONOMY WILL GO TO WORK WITH THE HIGH UNEMPLOYMENT RATE AND WAGES BEING BID DOWN, AND SO THINGS THAT ARE TAKING PLACE IN THE PRIVATE ECONOMY WILL AUTOMATICALLY SOLVE THIS PROBLEM. IT'S A SLOW PROCESS, PERHAPS, BUT IT WILL

4 ECO LECTURE TWENTY-FOUR 4 AUTOMATICALLY SOLVE THE PROBLEM OF THE RECESSIONARY GAP AND THE HIGH UNEMPLOYMENT RATE. HOW LONG DOES THAT TAKE TO MOVE FROM POINT A TO POINT B? AND THE ANSWER IS: THERE IS NO GENERAL ANSWER EVERY SINGLE TIME, EVERY ECONOMY. BUT I'M THINKING THAT ANYPLACE -- TWO, THREE, FOUR YEARS. COULD BE A LITTLE BIT LESS. IT DEPENDS. IF THAT'S A SMALL GAP, IT COULD BE A YEAR. BUT THE POINT IS, IT COULD TAKE A FEW YEARS. WHAT WE'RE DEALING WITH IS A SITUATION WHERE WAGES HAVE TO FALL TO MAKE THIS HAPPEN. AND PEOPLE MIGHT JUST GO IN, ESPECIALLY THE WORKERS WHO CONTINUE THEIR JOBS -- THEY DON'T JUST GO IN AND SAY, "CUT MY WAGE, PLEASE." AND IT'S VERY DIFFICULT TO GET THOSE WAGES DOWN THAT MUCH. SO FOR SURE IF AN EMPLOYER'S GOT A CONTRACT THAT LASTS, LET'S SAY, THREE YEARS WITH WORKERS, THAT SAYS WE'LL PAY YOU TWELVE DOLLARS AN HOUR FOR THE NEXT YEAR, FOR THREE YEARS THOSE WORKERS ARE LOCKED IN AT TWELVE DOLLARS AN HOUR. SO IT'S GONNA BE HARD TO GET WAGES DOWN IN THAT SITUATION. AND THREE YEARS IS NOT AN UNUSUAL PERIOD FOR WORKERS TO HAVE A CONTRACT THAT LONG. OKAY. SO ANYWAY, IT MIGHT TAKE THREE YEARS FOR THAT CONTRACT TO EXPIRE AND THEN FOR A NEW CONTRACT TO BE SIGNED AT TEN DOLLARS AN HOUR. BUT ANYWAY, THIS IS THE PROCESS WHERE THE ECONOMY

5 ECO LECTURE TWENTY-FOUR 5 NATURALLY SOLVES THE PROBLEM OF HIGH UNEMPLOYMENT. IT'S A SLOW PROCESS. WHAT WE WILL DO IS, WE'LL COME BACK IN LATER CHAPTERS AND WE'LL TALK ABOUT TWO GENERAL POLICIES, MONETARY POLICY AND FISCAL POLICY. BUT IN GENERAL, WHAT HAPPENS IS WE DON'T WAIT FOR THIS AGGREGATE SUPPLY CURVE TO SHIFT TO THE RIGHT THROUGH WAGE CUTS. IN GENERAL, WE DON'T DO THAT. IN GENERAL, WE JUST SAY, "WELL, WHY DON'T WE TRY TO GET TO NATURAL REAL GDP BY SHIFTING THE AGGREGATE DEMAND CURVE?" AND THIS IS NOT THE TIME FOR IT, BUT THE POINT IS IF WE HAD SHIFTED THE AGGREGATE DEMAND CURVE OUTWARD TO HERE, WHERE WE INTERSECTED THE ORIGINAL AGGREGATE SUPPLY CURVE, THE SHORT- RUN AGGREGATE SUPPLY, AND THE NEW AGGREGATE DEMAND, AD2, IF WE COULD DO THAT, THIS WOULD'VE BEEN AN EQUILIBRIUM AT NATURAL REAL GDP AND THE LOW UNEMPLOYMENT RATE. AND SO GENERALLY WHAT HAPPENS IS WE DON'T WAIT FOR THESE WAGE CUTS. MONETARY OR FISCAL POLICY COMES ALONG AND SHIFTS THE AGGREGATE DEMAND CURVE. HERE'S THE BAD NEWS ABOUT THAT. WHEN WE SOLVE THIS PROBLEM THROUGH INCREASES IN AGGREGATE DEMAND, YOU SAW THE PRICE LEVEL WENT WAY UP. WE HAD A LOT OF INFLATION. BUT NEVERTHELESS, THAT'S THE POLICY WE USUALLY HAVE. AS I SAY, IN A LATER UNIT OF MATERIAL WE'LL COME BACK AND TALK ABOUT MONETARY AND FISCAL POLICIES, HOW THEY CAN DO THESE THINGS THAT WE'RE TALKING ABOUT, RESTORE NATURAL REAL GDP AND LOWER THE

6 ECO LECTURE TWENTY-FOUR 6 UNEMPLOYMENT RATE. OKAY. LET'S GO ON TO THE OTHER SIDE OF THE -- OR THE OTHER POSSIBILITY, THE OTHER EXTREME, WHICH IS: SUPPOSE WE HAVE AN INFLATIONARY GAP. INFLATIONARY GAP, WHAT WE'RE TALKING ABOUT IN THIS PARTICULAR CASE IS EQUILIBRIUM REAL GDP IS GREATER THAN NATURAL REAL GDP. THIS IS VERY SIMILAR TO WHAT WE STARTED OFF WITH BEFORE. I'VE INDICATED NATURAL REAL GDP WITH THIS VERTICAL CURVE HERE AND I'VE LABELED THIS QN, NATURAL REAL GDP. AND NOW I'VE PUT THE UNEMPLOYMENT RATE DOWN ON THAT UNEMPLOYMENT AXIS DOWN LOWER AT FIVE PERCENT CORRESPONDING TO NATURAL REAL GDP. OKAY. WELL, THE ECONOMY WILL MOVE TO WHATEVER POINT IS SHOWN BY THE INTERSECTION, THE AGGREGATE DEMAND AND SHORT-RUN AGGREGATE SUPPLY CURVE. SO AT POINT A WE HAVE THE ECONOMY IN ITS EQUILIBRIUM POSITION. PRODUCTION ON THE ONE HAND IS BALANCED AGAINST SPENDING ON THE OTHER. AT THIS POINT A WHERE THE AGGREGATE PRICE LEVEL IS P1, REAL GDP IS Q1. NOW MAYBE WE HAVE SOMETHING LIKE THIS. THE UNEMPLOYMENT RATE IS -- OH, WHAT'LL IT BE -- FOUR PERCENT. THERE'S A LOWER UNEMPLOYMENT RATE AT THIS HIGH LEVEL OF REAL GDP. YOU REMEMBER REAL GDP IS HIGH. IT'S HIGHER THAN NATURAL REAL GDP. BUT ANYWAY, AS IT IS, THEN WE HAVE A LOWER UNEMPLOYMENT RATE. SO WHEN EQUILIBRIUM -- OH, HERE'S THE EQUILIBRIUM, Q1. WHEN EQUILIBRIUM REAL GDP AT Q1 IS GREATER THAN NATURAL REAL GDP, WE

7 ECO LECTURE TWENTY-FOUR 7 JUST SAY, "WELL, THERE'S AN INFLATIONARY GAP." THIS IS ALSO A SIGN THAT THERE IS LOW UNEMPLOYMENT. LOW UNEMPLOYMENT. THE UNEMPLOYMENT RATE IS BELOW THE NATURAL RATE OF UNEMPLOYMENT. OKAY. SO WHAT HAPPENS NOW? WELL, WHAT HAPPENS IN THE REAL WORLD MAY BE SOME POLICY, BUT THAT'S NOT WHAT WE'RE GONNA TALK ABOUT RIGHT NOW. BUT THERE MAY BE A POLICY, MONETARY OR FISCAL POLICY, TO SHIFT THAT CURVE. IF THERE'S NOT, IF WE JUST SET BACK AND WAIT AND SEE WHAT HAPPENS, HERE'S WHAT WILL HAPPEN: AT THE POSITION WE START OFF IN, POINT A, THE UNEMPLOYMENT RATE IS FOUR PERCENT. THAT'S A LOW UNEMPLOYMENT RATE. THERE'S A LOT OF PRESSURE ON JOB MARKETS. THERE'S A STRONG DEMAND. EVERYBODY THAT WANTS A JOB HAS GOT A JOB. I MEAN, THERE ARE PEOPLE BETWEEN JOBS, BUT NEVERTHELESS I'M SAYING IF YOU JUST SAY, "YOU KNOW, I'VE BEEN WATCHING SOAP OPERAS AND TAKING IT EASY FOR A FEW YEARS. NOW I THINK I'LL GET OUT AND LOOK FOR A JOB." YOU JUST GO OUT AND ALL OF A SUDDEN THERE'S THE JOB RIGHT NOW. IT TAKES NO TIME TO FIND A JOB. THE UNEMPLOYMENT RATE'S LOW BECAUSE THERE'S LOTS OF SPENDING, LOTS OF DEMAND AND SO FORTH, FOR YOUR SERVICES. AND SO THE UNEMPLOYMENT RATE IS LOW DURING THIS PERIOD THAT WE'RE COMING ONTO THE SCENE WITH THE INFLATIONARY GAP. SO YOU FIND A JOB QUICKLY. WHEN, IN FACT, MAYBE THE EMPLOYERS ARE SAYING, "OH, MAN. THERE'S JUST -- YOU KNOW, THE JOB APPLICANTS, THEY DON'T

8 ECO LECTURE TWENTY-FOUR 8 HAVE A LOT OF SKILLS. EVERYBODY WITH SKILLS, THEY'VE GOT JOBS. THERE'S JUST NOT MUCH IN THE WAY OF LABOR TO GO AROUND." OKAY. SO SITUATIONS LIKE THAT PREVAIL. AND THEN EMPLOYERS START SAYING THINGS LIKE THIS: "YOU KNOW, IF I WANT TO HIRE SOME REALLY QUALITY WORKERS, EVEN AVERAGE QUALITY WORKERS, I'M GONNA HAVE TO RAISE MY WAGE. BECAUSE IF I DON'T, I'M JUST GONNA GET THESE PEOPLE WHO ARE LIKE DROPPED OUT OF THIRD GRADE AND THAT'S THE ONLY PEOPLE THAT COME IN AND APPLY FOR A JOB HERE. IF I WANT TO GET PEOPLE THAT ARE -- YOU KNOW, HAVE THE NECESSARY SKILLS AND SO FORTH, THE JOB MARKET IS SO TIGHT I'M GONNA HAVE TO RAISE MY WAGE." SO THE EMPLOYERS START RAISING WAGES AT THAT POINT. AND IF YOU DON'T, NOBODY WILL APPLY. AND AS SOON AS WAGES START GOING UP -- LET ME COME BACK AND -- HERE'S THE WAGE RATE EQUALS, WE'LL SAY NOW, TWELVE DOLLARS AN HOUR TO START WITH. BUT AS SOON AS WAGES START TO GO UP DUE TO THIS TIGHT JOB MARKET, SOME PEOPLE WOULD SAY IT'S A SELLERS' MARKET -- DUE TO THE TIGHT JOB MARKET, HIGHER WAGES SHIFT THAT AGGREGATE SUPPLY CURVE TO THE LEFT. SO AS THE CURVE STARTS SHIFTING TO THE LEFT -- IT WILL SHIFT BY A LITTLE AND A LITTLE MORE, BUT FINALLY IT WILL SHIFT ALL THE WAY TO THIS POINT HERE, SRAS2. THAT'S DUE TO THE HIGHER WAGE. NOW THE WAGE RATE EQUALS, I'LL SAY, FOURTEEN DOLLARS AN HOUR.

9 ECO LECTURE TWENTY-FOUR 9 DOES ANYBODY KNOW WHAT THE WAGE RATE IS FOR NON-SUPERVISORY WORKERS, JUST PRODUCTION WORKERS IN THE UNITED STATES? IT'S ABOUT TWELVE DOLLARS AN HOUR RIGHT NOW. SO ANYWAY, WE'RE TALKING ABOUT NUMBERS THAT ARE BALLPARK NUMBERS. IF YOU GET ALL THE NON-SUPERVISORY WORKERS IN THE UNITED STATES, I'M SAYING THEIR AVERAGE WAGE WOULD BE AROUND TWELVE DOLLARS AN HOUR. SO ANYWAY, IF THERE'S A REAL LOW UNEMPLOYMENT RATE, THAT WAGE STARTS GOING UP AND IT WILL FINALLY SHIFT ALL THE WAY UP, IN THIS PARTICULAR CASE, TO FOURTEEN DOLLARS. THEN A NEW EQUILIBRIUM IS RESTORED AT POINT B. WHY DO I SAY THAT'S THE EQUILIBRIUM? 'CAUSE AGGREGATE DEMAND AND SHORT-RUN AGGREGATE SUPPLY INTERSECT AT POINT B. SO THE NEW EQUILIBRIUM REAL GDP IS QN. AND THE NEW UNEMPLOYMENT RATE IS FIVE PERCENT -- WHICH WE'VE, IN THIS PARTICULAR CASE, SAID THAT'S THE NATURAL RATE OF UNEMPLOYMENT. SO GUESS WHAT HAPPENED? WE STARTED OFF AT POINT A AND WE HAD INFLATION, RIGHT? THE PRICE LEVEL WENT UP. WE DID HAVE AN INFLATIONARY GAP AFTER ALL. BUT WE HAD INFLATION. WAGES WERE GOING UP AND COMPANIES WERE RAISING THEIR PRICES, AND FINALLY WE GOT TO A NEW HIGHER PRICE LEVEL AND WE GOT THE EQUILIBRIUM REAL GDP, AND NOW WE ARE IN A LONG-RUN EQUILIBRIUM. ONCE WE REACHED THIS POINT B, THERE'S NO MORE TENDENCY FOR WAGES TO RISE BECAUSE NOW THE UNEMPLOYMENT RATE IS FIVE PERCENT. AND THAT'S NOT AN

10 ECO LECTURE TWENTY-FOUR 10 EXCESSIVELY STRONG LABOR MARKET; IT'S JUST THE NATURAL RATE OF UNEMPLOYMENT. THERE ARE PEOPLE LOOKING FOR JOBS BUT THEY'RE JUST BETWEEN JOBS. THEY DON'T HAVE TO BE PAID MORE TO FIND -- TO TAKE A JOB, MORE THAN THEIR PREVIOUS JOB. THEY'RE JUST BETWEEN JOBS. THEY DIDN'T LIKE WHERE THEY USED TO WORK OR THEY MOVED, OR SOMETHING LIKE THAT. BUT THE POINT IS, IN THIS NEW SITUATION WE'VE COME UPON, THAT POINT B, THERE'S NOT PARTICULARLY STRONG CONDITIONS IN LABOR MARKETS AND SO WAGES STOP RISING. AND IF THEY STOP RISING, WE NO LONGER HAVE ANY MORE OF THESE SHIFTS IN THE AGGREGATE SUPPLY CURVE. QUESTIONS ABOUT THIS? NOW, THIS IS NOT SUCH A DIFFICULT THING FROM POINT A TO POINT B. LET ME GO BACK AND JUST QUICKLY SKETCH THIS THING OUT THAT WE HAD BEFORE WITH THE UNEMPLOYMENT -- OR THE RECESSIONARY GAP, AND I'LL JUST TAKE A SECOND TO DO THAT. QN, Q1, POINT A, POINT B. NOW, LET ME SHIFT THAT CURVE. IN THE PREVIOUS CASE WHEN WE HAD THE RECESSIONARY GAP, IN ORDER FOR THE ECONOMY TO AUTOMATICALLY MOVE US FROM POINT A TO POINT BE, WE HAD TO HAVE WAGE RATES COME DOWN. THAT WAS WHAT WAS SHIFTING THIS AGGREGATE SUPPLY CURVE TO THE RIGHT. I AM SAYING THAT THIS IS A DIFFICULT THING TO DO. PEOPLE WILL RESIST THAT, ESPECIALLY THE PEOPLE WHO AREN'T OUT OF WORK. AND IF -- LET'S SAY THAT YOU'RE STANDING IN SOME LINE, TRYING TO

11 ECO LECTURE TWENTY-FOUR 11 GET A JOB. YOU'RE WILLING TO TAKE A WAGE -- LET'S SAY THAT THEY'RE PAYING ALL THE WORKERS TWELVE DOLLARS. YOU MIGHT SAY, "HEY, I'M WILLING TO GO TO WORK FOR TEN." YOU MIGHT SAY THAT AND THE OTHER PEOPLE STANDING THERE IN LINE MIGHT SAY THAT, BUT THE PEOPLE WHO ARE INSIDE WORKING, THEY'RE NOT WILLING TO TAKE A PAY CUT JUST SO YOU CAN HAVE A JOB. AND SO I'M SAYING THIS PROCESS IS SOMETHING THAT -- IT COULD EASILY STRETCH INTO THREE YEARS FOR THE ECONOMY TO AUTOMATICALLY MOVE FROM POINT A TO POINT B. OVER HERE, THERE'S NOT THIS SAME NATURAL RELUCTANCE FOR WAGES TO GO UP. NOW, THERE IS AMONG EMPLOYERS BUT EMPLOYERS WILL PAY HIGHER WAGES IF THAT'S WHAT THEY HAVE TO DO TO GET THE WORKERS, 'CAUSE THEY'VE GOTTA HAVE WORKERS TO BASICALLY OPEN THE DOORS AND EARN A PROFIT. BUT THE POINT IS IS THAT THERE AREN'T THESE AS STRONG AN INSTITUTIONAL FORCES' NATURAL RELUCTANCE THAT WE HAD A MOMENT AGO FOR WAGES TO FALL. NOW WAGES CAN GO UP MUCH MORE EASILY. AND SO WHAT I'M SAYING TO YOU IS, IF WE FIND OURSELVES IN AN INFLATIONARY GAP AND THERE'S THIS LOW UNEMPLOYMENT RATE, AND WAGES START GOING UP -- NOW, I'M NOT SAYING IT TAKES THREE YEARS FOR THAT TO HAPPEN. THIS COULD HAPPEN IN A FEW MONTHS. OR AT LEAST WE'D GET ON THE ROAD AND MOVE IN THAT DIRECTION. BUT IN A YEAR OR TWO MAYBE, WHEREAS BEFORE I WAS SAYING THREE YEARS.

12 ECO LECTURE TWENTY-FOUR 12 MAYBE WE'RE TALKING ABOUT, I DON'T KNOW, ONE TO TWO YEARS NOW IN THIS PARTICULAR CASE FOR THAT ADJUSTMENT TO OCCUR. SO OUR ECONOMY -- I'M SAYING THERE'S THIS ASYMMETRY -- OUR ECONOMY ADJUSTS TO A RECESSIONARY GAP SLOWLY AND SOLVES THAT PROBLEM, BUT SLOWLY. AND IN AN INFLATIONARY GAP, MORE QUICKLY. AND WHY? BECAUSE PEOPLE WILL RESIST THEIR WAGES BEING CUT MUCH MORE THAN THEY WILL RESIST THEIR WAGES GOING UP. THEY WON'T RESIST THAT MUCH AT ALL. EMPLOYERS WILL RESIST THE WAGES GOING UP. BUT THE EMPLOYERS ARE BIDDING AGAINST EACH OTHER AND THEY NEED THOSE EMPLOYEES TO OPEN THE DOOR, SO THEY'RE GONNA PAY THOSE HIGHER WAGES. SO IT'S JUST A FASTER PROCESS OF ADJUSTMENT. QUESTIONS ABOUT THIS? OKAY. I WANT TO DRAW BOTH OF THESE AGAIN BUT PUT 'EM TOGETHER. I SHOULDN'T HAVE ERASED THAT. WHAT'S THE ECONOMY GONNA DO IN THIS PARTICULAR SITUATION? WE'RE STARTING OFF -- I'LL CALL THIS POINT A. WE'VE GOT A CERTAIN PRICE LEVEL; WE'VE GOT A CERTAIN REAL GDP. DO WE HAVE A RECESSIONARY GAP OR AN INFLATIONARY GAP? OR NO GAP? NO GAP. OKAY. SO WHAT'S GONNA HAPPEN TO WAGES? WELL, THE UNEMPLOYMENT RATE IS WHATEVER THE NATURAL RATE IS IN THIS PARTICULAR CASE. WE'VE BEEN WORKING WITH FIVE PERCENT. I DON'T MIND LEAVING IT ALONE AT FIVE PERCENT. THE UNEMPLOYMENT RATE IS FIVE PERCENT. I'M SAYING THE JOB MARKET IS NOT

13 ECO LECTURE TWENTY-FOUR 13 PARTICULARLY TIGHT IN TERMS OF, "BOY, YOU JUST CANNOT FIND A WORKER," AND IT'S NOT PARTICULARLY EASY IN THE SENSE OF, "BOY, THERE ARE JUST WORKERS EVERYWHERE TRYING TO GET JOBS." IT'S NEITHER ONE OF THOSE. THERE'S JUST NOT PRESSURE ON WAGES TO MOVE. SO IF WE START OFF AT THAT POINT A, WE STAY THERE. NOW, LET'S JUST SORT OF LEAVE THAT TO THE SIDE. I'M NOT GONNA ERASE IT 'CAUSE I WANT IT TO STAY THERE, BUT LET US START OFF -- LET'S SAY THIS IS OUR ORIGINAL AGGREGATE SUPPLY CURVE. LET'S SAY -- FORGET ABOUT THE BLUE CURVE. BUT LET'S JUST SAY WE START UP HERE AT THIS INTERSECTION, THIS POINT, OF SHORT-RUN AGGREGATE SUPPLY CURVE TWO AND THE AGGREGATE DEMAND CURVE. WE START OFF RIGHT THERE. WE HAVE A LOW UNEMPLOYMENT RATE, MAYBE FOUR PERCENT. DO WE CALL THIS AN INFLATIONARY GAP OR A RECESSIONARY GAP? IT'S AN INFLATIONARY GAP. WE'RE OUT HERE AT A GREATER LEVEL OF GDP, REAL GDP, THAN THE NATURAL LEVEL. THERE'S A VERY LOW UNEMPLOYMENT RATE AND WAGES ARE GONNA RISE. RIGHT? AND IF WAGES RISE, THE AGGREGATE SUPPLY CURVE SHIFTS TO THE LEFT AND WE MOVE FROM POINT B UP TO POINT A. IN ONE OR TWO YEARS, USUALLY NOT THREE BUT POSSIBLY. IF WE START OFF WITH THIS AGGREGATE SUPPLY CURVE, SRAS3, AT POINT C, WE FIND THE REAL GDP, Q2. SHOULD'VE BEEN 3, SHOULDN'T IT? I'LL GO BACK AND FIX THAT. THAT'LL BE 2 AND THIS ONE WILL BE 3. I JUST

14 ECO LECTURE TWENTY-FOUR 14 WANTED MY SUBSCRIPTS TO AGREE ALL THE WAY AROUND. IF WE START OFF AT POINT C, DO WE HAVE A RECESSIONARY GAP OR AN INFLATIONARY GAP? RECESSIONARY GAP. THE EQUILIBRIUM REAL GDP IS BELOW THE NATURAL REAL GDP. THE UNEMPLOYMENT RATE IS MAYBE NOW -- LET'S SAY SIX PERCENT HIGHER THAN NATURAL UNEMPLOYMENT RATE. THAT BEING THE CASE, WAGES WILL FALL. AS THE WAGES FALL, THE AGGREGATE SUPPLY CURVE SHIFTS TO THE RIGHT. WE MOVE FROM POINT C TOWARD POINT A. IT'S HARD TO GET AWAY FROM THAT VERTICAL LINE, ISN'T IT -- THAT NATURAL REAL GDP? THIS VERTICAL LINE, WHERE WE KEEP ON COMING BACK TO IT, IT'S THE INTERSECTION BETWEEN AGGREGATE DEMAND AND THE VERTICAL LINE -- I'M GONNA CALL THIS LRAS. THAT'S THE LONG-RUN AGGREGATE SUPPLY. THAT IS WHEN THESE JOB MARKETS, LABOR MARKETS, ARE IN FULL EQUILIBRIUM -- MEANING THE NATURAL RATE OF UNEMPLOYMENT PREVAILS. LONG-RUN AGGREGATE SUPPLY. NOT ONLY DO WE HAVE A SITUATION WHERE THE PRODUCTION OF GOODS AND SERVICES AND THE DEMAND FOR GOODS AND SERVICES MEET AND FIND AN EQUILIBRIUM PRICE LEVEL, BUT AT THIS POINT A THE JOB MARKET IS AN EQUILIBRIUM. THERE'S NO TENDENCY FOR WAGES TO GO UP, NO TENDENCY FOR WAGES TO GO DOWN. WE JUST STAY HERE. AND THAT IS WHY I'M GONNA CALL THAT THE LONG-RUN AGGREGATE SUPPLY CURVE. ANY QUESTIONS ABOUT THAT?

15 ECO LECTURE TWENTY-FOUR 15 LET ME FINISH UP WITH JUST ONE THING. YOU MAY BE ASKING YOURSELF THIS QUESTION. IF THIS IS SORT OF FULL EMPLOYMENT, UN IS EQUAL TO THE FULL EMPLOYMENT, UNEMPLOYMENT RATE, AND IF QN IS EQUAL TO THE NATURAL REAL GDP, HOW CAN WE EVER GET THE UNEMPLOYMENT RATE BELOW FOUR PERCENT? THAT IS TO SAY, IF PEOPLE ARE LIKE FULLY EMPLOYED WHEN THE UNEMPLOYMENT RATE IF FOUR PERCENT, HOW DO WE EVER GET BELOW THAT? NOW, WE WILL COME BACK TO THAT SUBJECT LATER ON IN THE SEMESTER, BUT THE ANSWER IS: BASICALLY, WORKERS CAME INTO THE JOB MARKET ASKING -- WHERE WERE WE HERE? MAYBE THE WAGE RATE IN THIS PARTICULAR CASE IS, I DON'T KNOW, TEN DOLLARS AN HOUR. OKAY. SO WHAT HAPPENED WAS -- I DON'T KNOW HOW MUCH I WANT TO TALK ABOUT THIS, JUST BECAUSE IT RAISES ANOTHER SUBJECT. BUT THE POINT IS, SOMETIMES WORKERS THINK, "I'D BE WILLING TO GO TO WORK FOR, LET'S SAY, TEN DOLLARS AN HOUR -- OR TWELVE DOLLARS AN HOUR." EXCUSE ME. "I'D BE WILLING TO GO TO WORK FOR TWELVE DOLLARS AN HOUR." AND IT MAY BE THAT THERE'S INFLATION TAKING PLACE IN THE ECONOMY. WHEN I SAID I WAS WILLING TO GO TO WORK FOR TWELVE DOLLARS AN HOUR, MAYBE INFLATION WAS RAISING THE PRICE LEVEL. AND THAT EVEN THOUGH I'M GETTING TWELVE DOLLARS AN HOUR IN DOLLARS, THAT HIGHER PRICES ARE THE REAL VALUE OF THIS. AND SO EVEN THOUGH I'M GETTING -- MAYBE I'M GETTING TWELVE DOLLARS AN HOUR IN NOMINAL

16 ECO LECTURE TWENTY-FOUR 16 WAGES, BUT MAYBE I'M ONLY GETTING TEN DOLLARS AN HOUR IN REAL WAGES. AND SO WHAT I'M SAYING TO YOU IS, PEOPLE WENT OUT THERE THINKING THAT, "HERE'S WHERE WE'RE GONNA END UP WITH THIS UNEMPLOYMENT RATE. I'M GONNA GET TWELVE DOLLARS AN HOUR IN WAGE." AND I'M SAYING IF YOU JUST GO OUT AND YOU'RE LOOKING FOR A JOB AND YOU SAY, "I'M HOLDING OUT FOR TWELVE DOLLARS AN HOUR," AND YOU DO SOME INTERVIEWS AND FINALLY YOU GET TWELVE DOLLARS AN HOUR, AND BY THAT TIME PRICES HAVE GONE UP, THAT TWELVE DOLLARS AN HOUR DOESN'T BUY AS MUCH. AND SO THE EMPLOYER IS WILLING TO PAY YOU TWELVE DOLLARS 'CAUSE PRICES HAVE GONE UP AND THE EMPLOYER IS SELLING THE PRODUCT FOR MORE, BUT ITS PURCHASING POWER TO YOU IS NOT THE FULL TWELVE DOLLARS YOU ORIGINALLY THOUGHT. ANYWAY, I DIDN'T MEAN TO GET TOO FAR AHEAD OF WHAT WE WANT TO DISCUSS HERE. BUT THE POINT IS, LATER ON WE'LL COME BACK AND TALK ABOUT BASICALLY INFLATION AND HOW IT WILL AFFECT ALL THIS, AND EXPECTATIONS OF THE WORKERS AND SO FORTH. WHERE OUR MATERIAL STOPS FOR THIS EXAM WAS RIGHT BEFORE I STARTED ASKING THIS QUESTION OF HOW COULD WE EVER GET BEYOND FULL EMPLOYMENT AND SO FORTH. THAT WILL NOT BE ON THIS EXAM. SO WHAT I DO WANT YOU TO KNOW FROM THIS DIAGRAM, THOUGH, IS HOW WE -- BASICALLY, WE SAID THIS IS GONNA BE A LONG-RUN AGGREGATE

17 ECO LECTURE TWENTY-FOUR 17 SUPPLY CURVE FOR THE ECONOMY. AND THE REASON IT WILL BE IS NOT ONLY DO WE HAVE EQUILIBRIUM IN THE MARKET FOR GOODS AND SERVICES, AS WE DO WHEN THE SHORT-RUN AGGREGATE SUPPLY AND THE AGGREGATE DEMAND CURVE INTERSECT. WE HAVE EQUILIBRIUM IN THE MARKET FOR GOODS AND SERVICES. BUT ALONG THIS CURVE, THE VERTICAL LONG-RUN AGGREGATE SUPPLY CURVE, WE HAVE EQUILIBRIUM IN THE MARKET FOR LABOR. AND LET ME JUST FINALLY ADD AND THEN I'LL STOP. I'VE ONLY BEEN TALKING ABOUT THE UNEMPLOYMENT RATE DOWN HERE FOR LABOR, BUT IT'S REALLY THE CASE FOR ALL RESOURCES, WHETHER IT'S CAPITAL EQUIPMENT OR BUILDINGS -- YOU KNOW, STRUCTURES -- OR OTHER RESOURCES THAT GO INTO PRODUCTION. IT'S ALSO THE CASE THAT AS REAL GDP GOES DOWN, A SMALLER REAL GDP, THERE'S A HIGHER UNEMPLOYMENT OF ALL RESOURCES, NOT JUST LABOR. AND IT'S NOT JUST THE WAGE RATE; THAT IF THE WAGE RATE RISES, WE MOVE FROM HERE TO HERE. YES, BUT ALSO IF THE RENT FOR A BUILDING RISES, WE MOVE -- AND OTHER RESOURCE PRICES WILL BE GOING UP. SO I DON'T MEAN TO JUST BE FOCUSING ON UNEMPLOYMENT. BUT IF YOU'LL REMEMBER, LABOR IS ABOUT SEVENTY PERCENT OF NATIONAL INCOME. NATIONAL INCOME IS THE EARNINGS OF ALL RESOURCES. AND SO SINCE LABOR IS LIKE SEVENTY PERCENT OF ALL THE RESOURCES HIRED BY COMPANIES, THEN FOR THE MOST PART IT IS LABOR AND IT IS WAGES THAT

18 ECO LECTURE TWENTY-FOUR 18 ARE EITHER GOING UP OR GOING DOWN AND THAT WE'RE TALKING ABOUT. ANYWAY, LET'S LEAVE IT THERE FOR THE DAY WITH LONG-RUN AGGREGATE SUPPLY. WHAT WE WILL DO NEXT TIME IS, WE WILL GO ON TO THE NEXT TOPIC AND IT WON'T BE LONG UNTIL WE'LL BE TALKING ABOUT FISCAL POLICY AND THEN MONETARY POLICY. THAT'S WHAT WE'LL DO NEXT. SO LONG.