Chapter 13. Aggregate Supply
H.W. pp. 402-3 #3, 4, 7
macromodel as_ad_phillips_curve #1, 4, 8
Skip the appendix
A couple of graphs from the previous edition
were omitted in the seventh edition.
Link to syllabus
Fig. 13-1, p. 386. Short-Run Aggregate
Supply Curve
Chapter 14. Aggregate Supply
H.W. pp. 420-21 #3, 4, 7
macromodel as_ad_phillips_curve #1,
4, 8
Skip the appendix
Fig. 14-1, p. 404. Short-Run Aggregate
Supply Curve
Aggregate supply equation (p. 402) is Y = Ybar + α (P – Pe). Recall that
Ybar is full employment output, which depends on Un, which is
problematical.
There are a couple of explanations for this curve. Each involves market
imperfections that are short lived, so that the long run supply curve is
vertical.
Sticky wages and prices imply that real wages may fall when AD (and
prices) rise, leading firms to hire more workers, and thus produce
more.
Several empirical issues: which wages of which labor group to
include (non-governmental, non-service, only full time). Take out
trends.
Imperfect information is an alternative explanation, in which all markets
clear, but misperceptions have occurred.
Verbal description of the imperfect information model: Farmer makes
production decisions based on price expectations, but if actual prices
exceed those expectations, then the farmers will produce more. This
explanation relies on the confusion of an increase in all prices and a
change in relative prices-the price the producer receives.
Does a derivation, using fix price and flexible price firms. Game
theory terminology sneaks in.
A related conclusion is that if inflation is higher, there will be more
confusion, and so the AS curve will be steeper.
Fig. 13-2, p. 387. Shifts in AD and Short Run Fluctuations
Fig. 14-2, p. 405. Shifts in AD and Short
Run Fluctuations
Traces through the effects of an increase
in AD, passing from A to B, then to C.
Leads to a section on the Phillips curve (pp. 406-407).
Rewrite the AS curve equation as P = Pe + (1/ α)(Y-Ybar), or more
generally, P = Pe + (1/ α)(Y-Ybar) + v where v is supply shock (p
oil), or π = πe + (1/ α)(Y-Ybar) + v (p. 407).
Using Okun’s law, this becomes π = πe + -β(U - UN) + v (p. 407)
Fig. 13-4, p. 394. Short Run Tradeoff
between Inflation and Unemployment
Figure 16.7 The Phillips Curve:
Concept and empirical data
McConnel/Brue textbook
Fig. 14-4, p. 412. Short Run Tradeoff
between Inflation and Unemployment,
a.k.a. the Phillips Curve.
Phillips Curve
– different
text:
Interpretation:
movement of
AD along a
stable AS.
Figure 16.8 page 299. Inflation rates and
unemployment rates, 1961-2002
Source: McConnel/Brue
Fig. 13-3, p. 392. Inflation and
Unemployment in the US
Fig. 14-3, p. 410. Inflation and
Unemployment in the US
Adverse supply shocks:
Increase price of oil. Major agricultural shortfalls. Large wage hikesespecially after wage price controls.
Solution: increased competition, little countercyclical policy, demise of
OPEC
Fig. 13-5, p. 394. Shifts in the Short Run
Tradeoff
Fig. 14-5, p. 413. Shifts in the Short Run
Tradeoff
For example, if πe increases.
Inflationary expectations: we can model inflationary expectations as
adaptive (regressive) so πe = π-1 or rational (forward looking).
Fig. 13-2, p. 387, compared to Fig.13-5, p. 394.
Effects of increases in inflationary expectations.
High PE
Low PE
Remember: Rational Expectations Theory says expectations change quickly.
Hysterisis is name given to idea that macro effects are long term.
Fig. 14-2, p. 405, compared to Fig.14-5,
p. 413. Effects of increases in inflationary
expectations.
Remember: Rational Expectations Theory
says expectations change quickly.
Hysterisis is the name given to the idea
that macro effects are long term.
Discussion of the sacrifice ratio: the amount of GDP that would have to
be given up to reduce inflation by 1 %. Estimates are usually less
than 5.
But rational expectations theory downplays this. People use all available
information to predict the future, including inflation. With better
information, etc., cycles will be shorter, and inflationary inertia will
be less important.
The ultimate implication is that beliefs are important, so the key is a
credible commitment to non-inflationary goals.
Table 13-1, p. 399
Table 14-1, p. 416. Unemployment during
the Volcker Disinflation
Inflation was reduced by 6%, GDP was
off by 19%, so the sacrifice ratio was
close to 3. Why? Volcker’s credibility.
Review
Phillips curve: intro, useful to talk about tradeoff, worked in 1960s;
interpreted as flip-side of AS
Movements along Phillips curve correspond to shifts of AD
Monetary or fiscal policy
Shifts (up or down) of Phillips curve correspond to shifts of AS:
Price of oil, wages
‘technology,’ weather, business taxes, gov’t regulation, etc.
and
Price (or inflationary) expectations [new idea]
Review
Phillips curve: intro, useful to talk about
tradeoff, worked in 1960s; interpreted as
flip-side of AS
Movements along Phillips curve
correspond to shifts of AD Monetary or
fiscal policy
Shifts (up or down) of Phillips curve correspond to shifts of AS:
(Price of oil, wages ‘technology,’ weather, business taxes, gov’t
regulation, etc.
and
Price (or inflationary) expectations [new idea – paradigm shift]
Graphs omitted from the previous edition
Fig. 13-1, p. 350 of older book.
Graphs from the sixth edition that are
skipped
Fig. 13-2, p. 352 of older book.
Discuss whether real wages should be pro-cyclical, or
anti-cyclical. Theory says they should be anti-cyclical, but
the data seems to suggest they are pro-cyclical.
As an additional theoretical comment, it is the case that how
closely foreign trade is considered is important in this discussion.
Fig. 13-1, p. 350. The Sticky-Wage
Model
Fig. 13-1, p. 350.
Previous edition
The Sticky-Wage
Model
Fig. 13-2, p. 352 . Previous Edition
The Cyclical Behavior of the Real
Wage
Fig. 13-2, p. 352. The Cyclical Behavior
of the Real Wage
Real Wages are pro-cyclical, not counter