Transcript Inflation
Unit 3: Aggregate Demand and Supply and Fiscal Policy Copyright ACDC Leadership 2015 1 The Phillips Curve Shows tradeoff between inflation and unemployment. What happens to inflation and unemployment when AD increase? Copyright ACDC Leadership 2015 In general, there is an inverse relationship between unemployment and inflation Copyright ACDC Leadership 2015 3 Short Run Phillips Curve When the economy is overheating, there is low unemployment but high inflation Inflation When there is a recession, unemployment is high but inflation is low 5% 1% SRPC Copyright ACDC Leadership 2015 2% 9% Unemployment 4 Short Run Phillips Curve What happens when AS falls causing stagflation? Increase in unemployment and inflation Inflation 5% SRPC1 1% SRPC Copyright ACDC Leadership 2015 2% 9% Unemployment 5 The Phillips Curve in real life isn’t like the textbook AD/AS and the Phillips Curve Copyright ACDC Leadership 2015 Shifts in AD and the SRPC Show what happens on both graphs if AD changes. Increase? Decrease? AD shifts cause movement along the SRPC. Price Level SRAS LRAS Inflation PLe AD AD3 Copyright ACDC Leadership 2015 QY GDPR AD2 SRPC UY Unemployment 8 Shifts in AS and the SRPC Show what happens on both graphs if AS changes. Decrease? Increase? AS shifts cause shifts of the SRPC. Price Level LRAS AS1 SRAS Inflation AS2 PLe SRPC1 AD Copyright ACDC Leadership 2015 QY GDPR SRPC2 SRPC UY Unemployment 9 AD/AS and the Phillips Curve What happens as we transition to the long run? Price Level LRAS AS2 AS Inflation LRPC PLe AD2 AD Copyright ACDC Leadership 2015 QY GDPR SRPC1 SRPC UY Unemployment 10 Short Run vs. Long Run In the long run there is no tradeoff between inflation and unemployment Inflation Long Run Phillips Curve 5% The LRPC is vertical at the Natural Rate of Unemployment 3% 1% Copyright ACDC Leadership 2015 2% 5% 9% Unemployment 11 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) 35-12 The Good, the Bad, and the Ugly Unemployment Inflation GDP Growth Good 6% or less 1%-4% 2.5%-5% Worry 6.5%-8% 5%-8% 1%-2% Bad 8.5 % or more 9% or more .5% or less Copyright ACDC Leadership 2015 13 The Misery Index Rate of Inflation + Rate of Unemployment = Misery Index Stagflation A period with simultaneously high, or rising, rates of both unemployment and inflation. Stagflation! . D 2008 Audit Exam Taxes and Aggregate Supply • Supply-side economics • Tax incentives to work, save, and invest – Boost AD and AS • The Laffer curve Tax Rate (Percent) 100 n m Laffer Curve m l Maximum Tax Revenue 0 Tax Revenue (Dollars) 35-17 Taxes and Aggregate Supply • Criticisms of the Laffer curve – Taxes, incentives, and time • Would lower taxes cause people to work more? Less? Why? – Inflation and higher real interest rates • AD increase may require restrictive monetary policy resulting in higher rates and less investment, negating the gains – Is there a perfect number? • Lower taxes worked for Reagan… – – – – Recession ended, tax revenues increased Why? AD? AS? LRAS? Economy was in recession. Tax cut worked as fiscal stimulus, boosting GDP and making the tax base larger. The LRAS did not really increase though. 35-18 Review!! Analyzing the Economy Graphically Copyright ACDC Leadership 2015 19 Use the following models to show full employment, a recessionary gap, and an inflationary gap. 1. PPC 2. Business Cycle 3. AD/AS 4. Phillips Curve Copyright ACDC Leadership 2015