Transcript Long-Run Aggregate Supply

PowerPoint Presentation by
Mehdi Arzandeh, University of Manitoba
Long-Run
Macroeconomic
Adjustments
16
LEARNING OBJECTIVES
LO16.1
LO16.2
LO16.3
LO16.4
LO16.5
Explain how the economy arrives at its long-run equilibrium.
Explain how to apply the long-run AD–AS model to explain inflation, recessions,
and growth.
Explain the short-run trade-off between inflation and unemployment (the Phillips
Curve).
Discuss why there is no long-run trade-off between inflation and unemployment.
Explain the relationship among tax rates, tax revenues, and aggregate supply.
© 2016 McGraw‐Hill Education Limited
16-2
16.1
From the Short Run to the Long Run
• Short-Run Aggregate Supply
• Input prices are inflexible
• aggregate supply curve is upwardly sloping
• Long-Run Aggregate Supply
• Input prices are fully flexible
• Vertical aggregate supply
• The transition
LO1
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16.1
From the Short Run to the Long Run
From the Short-Run AS to the Long-Run AS
• 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
• Lower demand for inputs
• Input prices fall
• Short run aggregate supply shifts right
• Return to potential output
LO1
© 2016 McGraw‐Hill Education Limited
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FIGURE 16-1
Short-Run and Long-Run Aggregate Supply
Short-Run
Aggregate Supply
Long-Run
Aggregate Supply
a2
P2
a1
P1
P3
a3
GDP3
GDPf
AS2
a2
b1
P2
AS1
AS3
a1
P1
P3
a3
c1
GDPf
GDP2
Real Domestic Output, GDP
LO1
ASLR
Price Level
Price Level
AS1
Real Domestic Output, GDP
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FIGURE 16-2
Equilibrium in the Long-Run AD-AS Model
Price Level
ASLR
P1
AS1
a
AD1
GDPf
Real Domestic Output
LO1
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16.2
Applying the Long-Run AD-AS
Model
• Demand-pull inflation occurs when an increase in
aggregate demand pulls up the price level
LO2
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FIGURE 16-3
Demand-Pull Inflation in the Long-Run AD-AS Model
AS2
Price Level
ASLR
P3
c
b
P2
P1
AS1
a
AD2
AD1
Qf Q2
Real Domestic Output
LO2
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16.2
Applying the Long-Run AD-AS
Model
•Demand-Pull Inflation
•In the short run, demand-pull inflation drives
up prices and output
•In the long run, output is restored to GDPf
and only the price level is higher
LO2
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16.2
Applying the Long-Run AD-AS
Model
•Cost-Push Inflation
•Cost-push inflation arises from factors that
increase the cost of production at each price
level
LO2
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FIGURE 16-4
Cost-Push Inflation in the Long-Run AD-AS Model
Price Level
ASLR
AS1
c
P3
P2
AS2
b
a
P1
AD2
AD1
Q2 Qf
Real Gross Domestic Product, GDP
LO2
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16.2
Applying the Long-Run AD-AS
Model
•Cost-Push Inflation: Policy Dilemma
•If government attempts to maintain full
employment, an inflationary spiral may occur
•Otherwise, the recession will linger, with high
unemployment and a loss of real output
LO2
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FIGURE 16-5
Recession in the Long-Run AD-AS Model
Price Level
ASLR
AS2
a
P1
P2
AS1
b
c
P3
AD1
AD2
Q 1 Qf
Real Domestic Output
LO2
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Production Possibilities and Long-Run Aggregate
Supply
FIGURE 16-6
Productions
Possibilities
Long Run Aggregate
Supply
A
𝑨𝑺𝑳𝑹𝟏
𝑨𝑺𝑳𝑹𝟐
𝑮𝑫𝑷𝟏
𝑮𝑫𝑷𝟐
Price Level
Capital Goods
C
B
D
Consumer Goods
Increase in production
possibilities
LO2
Real GDP
Increase in long-run
aggregate supply
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16.2
Applying the Long-Run AD-AS
Model
Recession and the Long-Run AD-AS Model
•How long would it take in the real world for
price and wage adjustments to occur to
regain full employment?
•There is disagreement among economists
LO2
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16.2
Applying the Long-Run AD-AS
Model
Ongoing Inflation in the Long-Run AD-AS Model
• Modern economies tend to experience positive rates of
inflation due to
• Economic growth causing rightward shifts of the AS curve
• Central banks then cause rightward shifts of the AD curve so
that it proceeds just a little faster than the deflationary
rightward shifts of the AS curve
• The net effect is (usually) a small positive rate of inflation
LO2
© 2016 McGraw‐Hill Education Limited
16-16
FIGURE 16-7
Depicting Canadian Growth in the Long-Run AD-AS
Model
ASLR1
ASLR2
AS2
Price level
AS1
P2
P1
AD2
AD1
0
Q1
Q2
Real GDP
LO2
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16.2
Applying the Long-Run AD-AS
Model
• Long-Run AD-AS Model
• Economic growth causes increases in long-run aggregate
supply
• Whether deflation, or inflation accompanies growth
depends on the extent to which aggregate demand increases
relative to aggregate supply
• Any inflation that occurs is the result of growth of aggregate
demand
• It is not the result of the growth of real GDP
LO2
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16.3
The Inflation-Unemployment
Relationship
• Under normal circumstances, there is a short-run
tradeoff between inflation & unemployment
• Aggregate supply shocks can cause both higher
inflation and higher unemployment
• There is no significant tradeoff between inflation
and unemployment over long periods of time
LO3
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FIGURE 16-8
Phillips Curve: Concept and Canadian Empirical Data
Empirical Data
The Concept
Data for the 1960s
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)
7
6
. 68 . 69
. 67
5
. 66
. 65
4
3
2
. 64
1
. 63
. 62
. 61
0
0
1
2
3
4
5
6
7
Unemployment Rate (Percent)
© 2016 McGraw‐Hill Education Limited
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FIGURE 16-9
The Short-Run Effect of Changes in Aggregate
Demand on Real Output and the Price Level
Price Level
AS
P3
P2
AD3
P1
P0
AD2
AD1
AD0
0
Q0
Q1 Q2 Q3
Real GDP
LO3
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16.3
The Inflation-Unemployment
Relationship
• The Phillips Curve
• Modern economists reject the idea of a stable,
predictable long-run Phillips Curve
• They agree there is a short-run tradeoff between
inflation and unemployment
LO3
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16.3
The Inflation-Unemployment
Relationship
• Aggregate Supply Shocks and the Phillips Curve
• In the late 1970s and early 1980s, the economy
experienced stagflation
LO3
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16.3
The Inflation-Unemployment
Relationship
• Adverse Aggregate Supply Shocks
• OPEC and Energy Prices
• Other shocks:
• Agricultural shortfalls
• Dollar depreciation
• Wage increases after wage-price controls lifted
• Declining productivity
LO3
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FIGURE 16-10
LO3
Inflation Rates and Unemployment Rates in Canada,
1961-2014
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16.3
The Inflation-Unemployment
Relationship
• Stagflation’s Demise
• By the late ‘80s, it appeared the Phillips curve had shifted
back
• Recession of ‘81-’83
• Increased foreign competition
• Deregulation of airlines and trucking
• Decline in OPEC’s power
• These factors also helped to reduce per-unit production
costs and to shift the short-run AS curve rightward
LO3
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16.1 GLOBAL PERSPECTIVE
The Misery Index, Selected Nations, 2001-2012
LO3
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16.4 The Long-Run Phillips Curve
There is no apparent long-run tradeoff between
inflation and unemployment
• The Short-Run Phillips Curve
• Expectation and the Long-Run Vertical Phillips Curve
• Disinflation
LO4
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FIGURE 16-11
The Long-Run Vertical 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
© 2016 McGraw‐Hill Education Limited
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16.5 Taxation and Aggregate Supply
•Taxes and Incentives to Work
•Government policies can impede or promote
rightward shifts of AS
•Effects of taxation on the supply curve are
key concerns of supply-side economics
LO5
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16.5 Taxation and Aggregate Supply
•Incentives to Save and Invest
•Lower marginal tax rates increase the
rewards for saving and investing
•Saving is a prerequisite for investment
LO5
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FIGURE 16-12
100
The Laffer Curve
Tax rate (percent)
n
Shows impact of tax rates
upon tax collections
Lower Tax Revenue
Above m
m
Maximum Tax
Revenue
l
0
Tax revenue (dollars)
LO5
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16.5 Taxation and Aggregate Supply
•Criticisms of the Laffer Curve
• Taxes, Incentives and Time
• Empirical evidence shows the impact of a tax cut on incentives is
small, of uncertain direction, and relatively slow to emerge
• Inflation or Real Interest Rates
• Demand side effects may be greater/quicker and certain
• Position on the Curve
•Rebuttal and Evaluation
LO5
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The LAST
WORD
Do Tax Increases Reduce Real GDP?
Determining the relationship between changes in taxes and permanent changes in real GDP is fraught
with complexities and difficulties. University of California-Berkeley economists Christina Romer and
David Romer have recently devised a novel way to approach the topic. Their findings suggest that tax
increases reduce real GDP.
• On average, when economic activity rises more rapidly, tax revenues also are
rising more rapidly
• Romer and Romer find that most tax changes are motivated by:
1. counteracting other influences in the economy;
2. paying for increases in government spending (or lowering taxes in conjunction with
reductions in spending);
3. addressing an inherited budget deficit;
4. promoting long-run growth
• A tax increase of 1 percent of GDP lowers real GDP by roughly 2 to 3 percent.
• Romer and Romer find that tax increases to reduce an inherited budget deficit
have much smaller output costs than other tax increases.
© 2016 McGraw‐Hill Education Limited
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Chapter Summary
LO16.1
LO16.2
LO16.3
LO16.4
LO16.5
Explain how the economy arrives at its long-run
equilibrium.
Explain in how to apply the long-run AD–AS model to
explain inflation, recessions, and growth.
Explain the short-run trade-off between inflation and
unemployment (the Phillips Curve).
Discuss why there is no long-run trade-off between
inflation and unemployment.
Explain the relationship among tax rates, tax revenues,
and aggregate supply.
© 2016 McGraw‐Hill Education Limited
16-35