Transcript short-run
Chapter 35 Extending the Analysis of Aggregate Supply McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved. From Short Run to Long Run • Short run –Input prices inflexible –Upward sloping aggregate supply • Long run –Input prices fully flexible –Vertical aggregate supply • The transition? 35-2 From Short Run to Long Run • Production above potential output: –High demand for inputs –Input prices rise –Short run aggregate supply shifts left –Return to potential output • Production below potential output • Graphical examples… 35-3 From Short Run to Long Run Short-Run Aggregate Supply Long-Run Aggregate Supply a2 P2 a1 P1 P3 a3 Q3 ASLR AS2 Price Level Price Level AS1 P2 Qf Q2 Real Domestic Output a1 P1 P3 a2 b1 AS1 AS3 a3 c1 Qf Real Domestic Output 35-4 Extended AD-AS Model Long Run Equilibrium Price Level ASLR AS1 a P1 AD1 Qf Real Domestic Output 35-5 Extended AD-AS Model Demand-Pull Inflation Price Level ASLR P3 AS1 b c P2 P1 AS2 a AD2 AD1 Qf Q2 Real Domestic Output 35-6 Extended AD-AS Model Cost-push inflation If government counters recession with spending… If government ignores recession… Price Level ASLR AS1 c P3 P2 AS2 b a P1 AD2 AD1 Q2 Q f Real Domestic Output 35-7 Extended AD-AS Model Recession Price Level ASLR P3 AS2 a P1 P2 AS1 b c AD1 AD2 Q1 Qf Real Domestic Output 35-8 Productivity Increases Long Run Growth/Inflation 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 35-11 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) 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) 35-12 The Phillips Curve The graphical representation of the relationship between the rates of Unemployment and Inflation. The Long-Run Phillips Curve At natural rate of unemployment 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) 35-15 Stagflation A period with simultaneously high, or rising, rates of both unemployment and inflation. Stagflation! . D The Misery Index Rate of Inflation + Rate of Unemployment = Misery Index Taxes and Aggregate Supply Supply-side economics Tax incentives to work Tax incentives to save and invest The Laffer curve 100 Tax Rate (Percent) • • • • n m Laffer Curve m l Maximum Tax Revenue 0 Tax Revenue (Dollars) 35-18 Taxes and Aggregate Supply • Criticisms of the Laffer curve –Taxes, incentives, and time –Inflation and higher real interest rates –Position on the curve • Rebuttal and evaluation 35-19 Taxes and Real GDP • New findings suggest tax increases reduce real GDP (Romer and Romer 2008) • Positive output shocks raise tax revenues • Difficult to separate effects of tax changes from other effects • Investment falls sharply in response to tax changes 35-20