Short Run Aggregate Supply
- Time is too short for wages to adjust to the price level
- Workers may not be aware of changes in their real wages due to inflation and have adjusted their labor decisions and wage demands accordingly
- Nominal Wages
- Amount of money received per hour per day or per year
- Sticky Wages
- Nominal wage level is set according to an initial price level and it does not vary
Price Level
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Wage Level
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Employment Level
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Implications
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1.Keynesian/
Horizontal
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Fixed
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Fixed
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Flexible
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Output depends upon changes in employment
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2.Intermediate
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Flexible
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Fixed
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Flexible
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Output depends upon changes in price level and employment
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3.Classical/
Vertical
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Flexible
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Fixed
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Fixed
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Output dependent upon changes in price level
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Long Run Aggregate Supply
- Time long enough for wages to adjust to the price level
Long Run Phillips Curve
- Relationship between unemployment
- Long Run Phillips Curve occurs at the natural rate of unemployment
- Represented by a vertical line
- No trade off between unemployment and inflation in the long run
- Means that the economy produces at the full employment level
- Long Run Phillips Curve will only shift if the LRAS curve shifts
- More worker benefits create higher natural rates
- Fewer worker benefits create lower natural rates
Short Run Phillips Curve
- Tradeoff between unemployment and inflation (inverse relationship)
- High inflation equal to low employment
- Relevance to Okun’s Law
- Since wages are sticky, inflation changes move the points on the SRPC
- If inflation persists, and the expected rate of inflation rises then the entire SRPC moves upward due to stagflation
- If inflation expectations drop, due to new technology or economic growth then the SRPC moves downward
- Aggregate supply shocks cause both the rate of inflation and the rate of unemployment to increase
- Supply shocks- Rapid and significant increase in resource cause
- Misery Index- Combination of inflation and unemployment in any given year; single digit misery is good
Long-Run Phillips Curve
- LRPC exists at the natural rate of unemployment so structural changes that affect the natural rate of unemployment will also cause the LRPC to shift
- Increases in the natural rate of unemployment will shift the LRPC to the right
- Decreases in the natural rate of unemployment will shift the LRPC to the left
Stagflation
- When Inflation and Unemployment increase simultaneously
- 1946-1964 Baby Boom
- Women’s Movement
- Civil RIghts Movement
- Vietnam War ends
- Oil Embargo of 1973 & 1979
Disinflation
- Reduction in the inflation rate from year to year
- Occurs when aggregate demand declines
Deflation
- General drop in the price level
Supply Side Economics
- The belief that the AS curve will determine levels of inflation, unemployment, and economic growth
- To increase the economy, the AS curve will have to shift to the right which will benefit the company first
- Supply side economist focus on marginal tax rates
- Marginal Tax Rates: Amount paid on the last dollar earned or on each additional dollar earned
- Lower taxes or incentives for businesses to invest in our economy
- Lower taxes or incentives for workers to work more and harder thereby becoming more productive
- Lower taxes or incentives for people to increase savings and therefore create lower interest rates which will increase business investment
- Supply Side Economists Support policies that promote GDP Growth by arguing that high marginal tax rates along with our current system of transfer payments (Unemployment compensation/welfare programs) provide disincentives to work, invest, innovate, and undertake entrepreneurial ventures
Reaganomics
- Lowered the marginal tax rate to get the U.S. out of a recession. This actually led to a deficit.
Laffer Curve
- Trade off between tax rates and government used to support supply side argument
- As tax rates increase from zero, tax revenues increase from zero to some maximum level and then decline
- Three criticisms of the laffer curve:
- Research suggests that the impact of tax rates on incentives to work, invest, and to save are small
- Tax rates also increase demand which can fuel inflation and it causes demand to exceed supply
- Where the economy is actually located on the curve is yet to be determined
Focus 4/15/15
- Debit/Capital
- Credit/Current
- Debit/Capital
- Debit/Current
- Credit/Current
- Debit/Official Reserves
Foreign Exchange
- The buying and selling of currency
- The exchange rate (e) is determined in the foreign currency markets
- The exchange rate is the price of a currency. Do not try to calculate the exact exchange rate
Tips
- Always change the D line on one currency graph, the S line on the other currency’s graph
- Move the lines of the two currency graphs in the same direction (right or left) and you will have the correct answer
- If D on one graph increases, S on the other will also increase
- If D moves to the left, S will move to the left on the other graph
Changes in Exchange Rates
- Exchange Rates (e) are a function of the supply and demand for currency
- An increase in demand for a currency will make it more expensive to buy one unit of that currency
- A decrease in demand for a currency will make it cheaper to buy one unit of that currency
Appreciation
- Appreciation of a currency occurs when the exchange rate of that currency increases
Depreciation
- Depreciation of a currency occurs when the exchange rate of that currency decreases
Exchange Rate Determinants
- Consumer Tastes
- People want Japanese goods, more dollars go there, increasing Yen
- Relative Income
- Mexico has stronger economy than US, more US products being bought, more demand for dollars, USD appreciates, pesos depreciate
- Relative Price Level
- Higher price level, less demand
- Speculation
- Swiss interest rates will rise, greater demand for their money, appreciates value
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