Transcript From Short Run to Long Run

35
Extending the Analysis of Aggregate
Supply
McGraw-Hill/Irwin
Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.
From Short Run to Long Run
• Short run
• Wages and other input prices don’t
•
LO1
change.
• Upsloping aggregate supply
Long run
• Wages and other input prices fully
flexible
• Vertical aggregate supply.
35-2
From Short Run to Long Run
• Production above potential output:
• Price level increases.
• Nominal wages eventually rise to
maintain real wages (purchasing power).
• Other input prices rise
• Short run aggregate supply shifts left
because costs are higher.
• Return to potential output at a higher
price level.
LO1
35-3
Extended AD-AS Model
Increased Demand -- Short
Long Run
Price Level
LRAS AS2 AS
1
P3
c
b
P2
P1
a
AD2
AD1
Qf Q2
Real Domestic Output
LO2
35-4
From Short Run to Long Run
• Production below potential output:
• Price level decreases.
• Nominal wages eventually fall to
maintain real labor costs.
• Input prices fall.
• Short run aggregate supply shifts right
because costs are lower.
• Return to potential output at a lower
price level.
LO1
35-5
Extended AD-AS Model
Long Run
Run
Decreased Demand - Short
Price Level
LRAS AS1
a
P1
P2
P3
AS2
b
c
AD1
AD2
Q1 Qf
Real Domestic Output
LO2
35-7
From Short Run to Long Run
So what is it about full employment that
keeps bringing everything back here?
Price Level
ASLR
AS1
a
P1
AD1
Qf
Real Domestic Output
LO1
35-8
From Short Run to Long Run
It’s the level of employment at which there is neither
upward nor downward pressure on wages and input
prices.
Price Level
ASLR
AS1
a
P1
AD1
Qf
Real Domestic Output
LO1
35-9
Extended AD-AS Model
Demand-Pull Inflation
Price Level
ASLR
P3
AS1
c
b
P2
P1
AS2
a
AD2
AD1
Qf Q2
Real Domestic Output
LO2
35-10
Extended AD-AS Model
Cost-Push Inflation
Price Level
ASLR
AS1
c
P3
P2
AS2
b
a
P1
AD2
AD1
Q2 Q f
Real Domestic Output
LO2
35-11
Extended AD-AS Model
Recession
Price Level
ASLR
P3
AS2
a
P1
P2
AS1
b
c
AD1
AD2
Q1 Qf
Real Domestic Output
LO2
35-12
Inflation and Unemployment
• Low inflation and unemployment
• Fed’s two major goals
• Compatible or conflicting?
• Short-run tradeoff between inflation
•
•
LO3
and unemployment
Supply shocks cause both rates to
rise
No long-run tradeoff
35-16
The Phillips Curve
• Demonstrates short-run tradeoff between
inflation and unemployment
Concept
Empirical Data
7
6
5
4
3
2
1
0
0
1
2
3
4
5
6
Unemployment Rate (Percent)
LO3
7
Annual Rate of Inflation (Percent)
Annual Rate of Inflation (Percent)
Data for the 1960s
7
69
6
5
68
4
66
67
3
65
2
1
64
63
62
61
0
0
1
2
3
4
5
6
7
Unemployment Rate (Percent)
35-18
The Phillips Curve
Annual rate of inflation (percent)
14
13
12
11
10
9
8
7
6
5
4
3
2
1
Unemployment rate (percent)
LO4
35-19
The Long-Run Phillips Curve
PCLR
Annual Rate of Inflation (Percent)
15
PC3
12
b3
PC2
9
a3
b2
PC1
6
c3
a1
c2
b1
3
0
a2
3
4
5
6
Unemployment Rate (Percent)
LO4
35-20
The Phillips Curve
• No long-run tradeoff between inflation
and unemployment
• Short-run Phillips curve
• Role of expected inflation
• Long-run vertical Phillips curve
• Disinflation
LO4
35-22
Taxes and Aggregate Supply
• Supply-side economics
• Tax incentives to work
• Tax incentives to save and invest
• The Laffer curve
Tax Rate (Percent)
100
n
m
Laffer Curve
m
l
Maximum
Tax Revenue
0
Tax Revenue (Dollars)
LO5
35-24
Taxes and Aggregate Supply
• Criticisms of the Laffer curve
• Taxes, incentives, and time
• Inflation and higher real interest
•
LO5
rates
• Position on the curve
Rebuttal and evaluation
35-25
Taxes and Real GDP
• New findings suggest tax increases
•
•
•
LO5
reduce real GDP (Romer and Romer,
2008)
Positive output shocks raise tax
revenues
Difficult to separate the effects of tax
changes from other effects
Investment falls sharply in response
to tax changes
35-26