Transcript Money Output & Prices in the Long Run

Money Output & Prices in
the Long Run
Chapter 14-4
The Short-Run and Long-Run Effects of
an Increase in the Money Supply
LAS Curve
LAS
• Estimating potential output is
inexact, so it is assumed to be the
middle of a range bounded by a
high level of potential output and a
low level of potential output.
C
• The relationship between
Price Level
B
A
potential and actual output – where
the economy is on SAS – determines
shifts in SAS.
SAS
• When resources are over-utilized
Underutilized
resources
(point C), factor prices may be bid
up and the SAS shifts up.
Overutilized
resources
• When resources are under-utilized
Lowlevel
potential
output
High-level
potential
output
Real
output
(point A), factor prices may decrease
and SAS shifts down.
• When LAS = SAS (point B), there is
no pressure for prices to rise or fall.
Price level
Inflationary Gap
• An inflationary gap is the
LAS
amount by which equilibrium
output is above potential
output.
D
P2
SAS2
C SAS
C
0
P0
AD
Inflationary
gap
YP
Real
Y2
output
• If the economy is at point C,
resources are being used
beyond their potential and
the inflationary gap is YP – Y2.
• If resources are used
beyond their potential,
eventually wages and prices
increase. SAS shifts up to
SAS2 and the economy is in
long-run and short-run
equilibrium at D at a higher
price level, P2.
Neutrality

In the long run, changes in the money
supply affect the aggregate price
level but NOT real GDP or the
interest rate.
Monetary Neutrality

In fact, there is monetary neutrality:
changes in the money supply have no
real effect on the economy. So
monetary policy is ineffectual in the
long run.
This is the main point of this section!
The Long-Run Relationship
Between Money and Inflation
MV=PQ
Do you remember the above?
The previous graph is showing that
more money = higher prices
We know this to be true in the long run,
there is debate about the short run.