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Intermediate Macroeconomics Notes Week #14

by: Zachary Hill

Intermediate Macroeconomics Notes Week #14 ECON 3020

Marketplace > Tulane University > Economcs > ECON 3020 > Intermediate Macroeconomics Notes Week 14
Zachary Hill
GPA 3.88

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About this Document

These notes cover the rest of deriving Aggregate Supply and the combination and interaction of Aggregate Demand and Aggregate Supply.
Intermediate Macroeconomics
Antonio Bojanic
Class Notes
Econ, ECON3020, Macroeconomics, IntermediateMacroeconomics, Bojanic
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This 6 page Class Notes was uploaded by Zachary Hill on Sunday April 24, 2016. The Class Notes belongs to ECON 3020 at Tulane University taught by Antonio Bojanic in Fall 2015. Since its upload, it has received 59 views. For similar materials see Intermediate Macroeconomics in Economcs at Tulane University.


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Date Created: 04/24/16
ECON 3020 Notes for Week #14  ● The basis for deriving the AS curve is the Phillips curve which graphs unemployment and  inflation rates, showing that they seem to have an inverse relationship  ● Up until 1969, this relationship held  ●   ● This was very important if it held because it meant that an economy could control the  unemployment rate by controlling the inflation rate  ● Solow and Samuelson supported this  ● After 1969 this relationship broke down and there seemed to be no relation between the  unemployment and inflation rate  ● In the late 1960s Freidman and Phelps, individidually, stated that the PC  had a big  problem; the original curve, which used growth in workers wages, only used nominal  wages, not real wages; if prices increased in the economy, workers would demand  higher wages  ● The relationship of the PC  may hold in the short run, but cannot hold in the long run  because in the long run a country will experience their own level of natural  unemployment  ● Friedman and Phelps’s adjusted PC : π = π − w(U − U )nwhere π  is expected inflation,  w is the sensitivity to changes in the unemployment gap, U  is the actual unemployment  rate, and U nis the natural unemployment rate  ● For U n 5% and π = 2%  ●   ○ The LRPC  occurs at U  benause in the long run the economy will always tend  toward U  n ○ As the government attempts to achieve a U < U , the economy momentarily  n achieves the goal rate at a higher π, but this new rate increases π  for the next  e period, shifting the PC  up so that U noccurs at the new π ; this will continue  until the government allows U = U   n ● Another issue that Friedman and Phelps overlooked was supply shocks  ● Supply shock cause π  to increase or decrease regardless of the PC  previously  established  ● This must be incorporated, so the modern short­run PC  is represented by  π = π − w(U − U )n+ P  where P  is the effect of a supply shock  ● Because it is difficult to calculate expected inflation, it is generally guessed to be the  same as the rate of the previous year  ● U n NAIRU  (non­accelerating inflation rate of unemployment); the U  where Δπ = 0        20 April 2016  ● Using the PC  we are able to see that if U  does not change depending on inflation in the  long run, then the real production of an economy should also not change depending on  inflation in the long run  ●   ○ Y  is potential output, the output possible if the economy operates at perfect  P efficiency (full employment of resources/U )n ○ This falls in with the classical dichotomy; in the long run, real output is unaffected  by the price level  ● Short­run AS curve  ○ Association in the Y  (Y − Y )Pgap and the U  (U − U ) gnp shows that as the Y   gap increases, the U  gap decreases; this is Okun’s Law   ○ Applied to the US, Okun’s Law gives the following equation:  (U − U n =− 0.5(Y − Y )  P ○ If an economy is producing higher than its Y , then it will experience a U  less  P than its U n e ○ Then combining Okun’s Law and the short­run PC  we get π = π − w(U − U ) + P  n π = π − w(− 0.5(Y − YP)) + P   π = π + 0.5w(Y − Y P + P , let 0.5w = γ or the sensitivity factor of π to the Y    gap  π = π − γ(Y − Y ) + P   P e ○ Recall that π  should equal or be close to the π for the previous period  ○ For γ = 1.5 , π = 2%, and Y P $10 billion  ○   ○ If Y > YP, then U < U n(Okun’s Law)  ○ If U < Un, then π ↑ (short­run PC)  ● Factors that shift AS curve  ○ LRAS curve  ■ If Un decreases, the curve shifts rightward; this is a sign the economy is  utilizing labor more intensely, increasing itsPY   ■ Increase in factors of production (L, K, and technology) also shift the  curve rightward  ■ The opposite of these actions can also occur  ■ LRAS curve is shifting to the right at most time because L, K , and  technology are generally increasing over time  ○ SRAS curve  ■ The curve shifts upward if π  increases, if there is a positive supply shock  (P ↑), or there is a persistent positive output gap (the government causes  Y > YP)  ■ The opposite of these can also occur        22 April 2016  ● The AD curve shows the inverse correlation between π and aggregate output; it is  shifted by changes in G, C , I , T , and NX   ● The AS curve  ○ LRAS curve shows no relationship between production levels and π; shifted by  changes in technology, changes in U   n ○ SRAS curve shows the positive correlation between π and production levels;  shifted by changes in π , supply shocks, and persistent income gaps  ● Suppose the AD curve is given by Y = 11 − 0.5π and the SRAS curve is given by  π = 2 + 1.5(Y − 10)  ○   ○ Short­run equilibrium occurs where they intersect; this can be found by plugging  one in for the other and solving, and then using the solved value to find the  remaining variable from either equation  ○ Y = 11 − 0.5(2 + 1.5(Y − 10))  Y = 11 − 1 − 0.75(Y − 10)  Y = 10 − 0.75Y + 7.5  1.75Y = 17.5  Y = $10  Then Y = 10 = 11 − 0.5π, so π = 2%  ○ The short­run equilibrium also gives the long­run equilibrium which occurs at the  same Y   ● When the long­run equilibrium and the short­run equilibrium does not occur at the same  point, the SRAS curve will shift to make them equal; this is called the self­correcting  mechanism  ● If a supply shock occurs, the government must choose whether to reestablish long­run  equilibrium to keep Y  and U  near the correct levels at the cost of high π or not; no right  answer 


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