Short-Run vs. Long-Run

Short-Run No time for economy to make adjustments Nominal wages remain fixed as price level changes Long-Run Economy has sufficient time to make adjustments Nominal wages are responsive to price level changes

Graph of Extended AD-AS model

Why is LRAS vertical? Demand-pull inflation increases AD, PL increases, output increases…. If PL increases, workers real wages decrease, causes unrest Workers receive increase in nominal wages to increase purchasing power… Causes SRAS to shift left….. Cycle repeats over time…..

Recessionary gaps vs. Inflationary Gaps The amount by which agg. Expenditures at the full-employment GDP fall short of those required to achieve full employment GDP Recessions shift AD left Where would this be on a graph? Inflationary gaps The amount by which agg. Expenditures at full-employment GDP exceed those necessary to achieve full-employment GDP. Inflation shifts AD right Where would this be on a graph?

Graphs – which is which?

Macro instability – Cost-push inflation If AD shifts right due to cost-push inflation, what happens to PL and unemployment? Price level increases, but unemployment decreases Generalization – there is an inverse relationship between inflation and unemployment The dude that came up with this idea is A.W. Phillips…so we call this the Phillips curve

Phillips Curve

So what? This explains a basic theory of macroeconomics….output creates jobs, but comes at a price….an increased price….hahaha Get it? Do ya? Seriously, do you get it?

Stagflation Refutes the Phillips curve generalization Increasing PL and Unemployment rate Due to shock (unexpected) to AS determinants such as increases in resource costs… Example – OPEC during the 1970’s….

Long-Run Phillips Curve

Supply-Side Economics Enough Said….

Supply-Side Economics Proponents believe that changes in AS must be recognized as active forces in determining the levels of both inflation and unemployment. As adverse conditions arise, the government can manipulate AS to reduce these problems.

Characteristics of Supply-Side policies Lower taxes to increase incentive to work Reductions in marginal tax rates increase the nation’s aggregate supply. And, this reduction could possibly lead to increased tax revenue (Arthur Laffer) Exhibited by Laffer curve

Laffer Curve

Characteristics Continued…. Reduce public transfer programs that diminish the crisis of being unemployed. Reduce government regulation Increase incentives to save and invest Mostly done by lowering marginal tax rates