1. ECON 102 Tutorial: Week 24 Shane Murphy

2. Today’s Outline
Week 24 worksheet – Money & Inflation

3. Question 1
ISLM analysis (with r and Y on respective axes) is based upon the assumption that prices (P) remained unchanged as the money supply is increased. When that assumption is relaxed, the aggregate demand curve (with P and Y on respective axes) appears. Where the money supply is constant at M1, explain (in no more than 50 words) the representation of the different magnitude of the general level of prices (P1 > P2 > P3):

4. Question 1
An decrease in prices leads to a decrease in real money and the LM curve shifts

5. Question 2
Consider a rightward shift of the aggregate demand curve. A) What might happen to the general level of prices and to the level of employment? a) Only prices will increase b) Only employment will increase c) Prices will increase and employment will decrease d) One or the other or both may increase

6. Question 2
Consider a rightward shift of the aggregate demand curve. B) Which is more likely and when? In the short-term output is more likely to rise in a recession In the long-term, fiscal deficit spending increases the volume of bonds/currency in circulation which is (potentially) inflationary.

7. Question 3
Explain the relevance of aggregate supply to your answer to question 2. If, as retail prices begin the rise, there is no price/wage spiral, then inflation is unlikely; but, by the experience of the UK in the 1970s, neither high unemployment nor ‘incomes policy’ inhibit a price/wages spiral.

8. Question 4
Which variable remains constant along a given aggregate supply curve?
Interest rates
Output
The money wage
Optimal fiscal policy
Explain the relevance of that constancy.
this implies (for a left-to-right upward sloping aggregate supply curve) that the rise in the general level of prices is assumed not to trigger a price/wage spiral.

9. Question 5
How would you represent a price/wage spiral within the geometry of aggregate demand and aggregate supply? Aggregate demand and supply curves shifting ever-upwards

10. Question 6
Which circumstances are represented by an Aggregate Supply schedule that is (a) vertical (b) horizontal (c) upward sloping (left to right)? Match the situation with the outcome: Unit costs of production are unchanged as income/output rises. The case addressed by Keynes in TGT: ‘expansionary’ macroeconomic policy raises both output and unit costs which, passed on as higher prices, reduces real wages and eliminates involuntary unemployment. Long-run equilibrium: ‘expansionary’ macroeconomic policy generates inflation only

11. Question 6
Which circumstances are represented by an Aggregate Supply schedule that is (a) vertical (b) horizontal (c) upward sloping (left to right)? Match the situation with the outcome: b) Unit costs of production are unchanged as income/output rises. c) The case addressed by Keynes in TGT: ‘expansionary’ macroeconomic policy raises both output and unit costs which, passed on as higher prices, reduces real wages and eliminates involuntary unemployment. a) Long-run equilibrium: ‘expansionary’ macroeconomic policy generates inflation only

12. Question 6
Which circumstances are represented by an Aggregate Supply schedule that is (a) vertical (b) horizontal (c) upward sloping (left to right)?
Long-run equilibrium: ‘expansionary’ macroeconomic policy generates inflation only
Unit costs of production are unchanged as income/output rises.
The case addressed by Keynes in TGT: ‘expansionary’ macroeconomic policy raises both output and unit costs which, passed on as higher prices, reduces real wages and eliminates involuntary unemployment.

13. Question 6
The following passage is from Keynes’s General Theory: ‘Men are involuntarily unemployed if, in the event of a small rise in the price of wage-goods, relative to the money-wage, both the aggregate supply of labor willing to work for the current money-wage and the aggregate demand for it at that wage would be greater than the existing volume of unemployment.’

14. Question 6
The following passage is from Keynes’s General Theory: ‘Men are involuntarily unemployed if, in the event of a small rise in the price of wage-goods, relative to the money-wage, both the aggregate supply of labor willing to work for the current money-wage and the aggregate demand for it at that wage would be greater than the existing volume of unemployment.’ Using modern terminology and vocabulary, and with reference to the diagram above a) Rewrite the passage
Suppose price inflation (from P1 to P2) erodes the purchasing power of wages (W). If the effect is to increase (beyond the current level of employment, E1) both the number of individuals willing to work at those earnings levels (L1) and the number of jobs that are available at those earnings levels (E2), then involuntary unemployment is said to exist

15. Question 6
The following passage is from Keynes’s General Theory: ‘Men are involuntarily unemployed if, in the event of a small rise in the price of wage-goods, relative to the money-wage, both the aggregate supply of labor willing to work for the current money-wage and the aggregate demand for it at that wage would be greater than the existing volume of unemployment.’ B) Re-define the words in bold a) ‘employment level’; ‘output’ or ‘GDP’ b) ‘cost of living’ or ‘retail prices’; ‘earnings’ c) ‘wages’ or ‘earnings’; ‘output’ or ‘GDP’ d) ‘real money’; ‘price level’

16. Next Class Exam on Friday Week 25 is the last tutorial!
Check your Timetable for exam time & location.
Bring your Student ID Number, Pencil, Eraser.
Good luck!
Week 25 is the last tutorial!
I’ll plan on reviewing the Week 24 Exam 4 in class.