A Little Economics Joke…

Extending the Analysis of Aggregate Supply Chapter 35

From Short Run to Long Run Short-run is the time period in which nominal wages (and other inputs) don’t respond to price-level changes In other words, just because prices went up, doesn’t mean your paycheck went up (yet) This concept is actually referred to as sticky wages because your wages are slow to rise despite other things in the economy rising. Long-run is when wages are fully responsive to previous changes in price level Your paycheck goes up because the price level increased a year ago – unless you teach in Lake Co.

Demand-Pull Inflation When demand increases beyond the point of LRAS it will cause inflation—this is known as demand-pull inflation Notice that AD shifted right, but eventually that causes AS to shift left, resulting in output equalizing out, but prices being higher (inflation)

Cost-Push Inflation Cost-push inflation occurs when the cost of production forces businesses to increase the price they sell goods and services for If they try to move right, they will end up having to move back left to be in sync with the LRAS

Cost-Push Inflation Why would they increase production when they know that it will result in inflation? If things cost more to make then you need to make more of them to continue making a profit. Example, if labor goes up and workers still make the same number of shoes, the business will lose money The end result however is that in the LONG run AD will shift left along the curve. The business will still make a profit because prices went up

Aggregate Supply Shocks When a large, sudden increase in resource costs pushes the economy’s SRAS leftward When OPEC quadrupled their oil prices in the 70s, it jumped the cost of everything up This caused an increase in price and a decrease in output which also equals increased inflation and increased unemployment That combination is also known as stagflation

The Inflation-Unemployment Relationship Since low unemployment and low inflation are economic goals it is necessary to look at their relationship There are three generalizations that can be made: Normally, there is a trade-off between inflation and the unemployment rate AS shocks can cause both higher unemployment and higher inflation There is no significant trade-off between the two in the long run

The Phillips Curve Lower unemployment has in inverse relation with inflation (and vice versa) This causes a downward sloping line or a concave line The Long Run Phillips Curve (LRPC) shows that in the LONG run unemployment will have a natural rate at which it exists - p 727 LRPC Inflation Rate % PC Unemployment Rate %

Supply Side Economics They say that government policies can either impede or assist economic growth If taxes are high, the incentive to work, save and invest are lessened To promote growth, lower taxes are needed This is evidenced by the Laffer Curve - p 731