1. Short-Run vs. Long-Run

2. 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

3. Graph of Extended AD-AS model

4. 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…..

5. 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?

6. Graphs – which is which?

7. 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

8. Phillips Curve

9. 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?

10. 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….

11. Long-Run Phillips Curve

12. Supply-Side Economics
Enough Said….

13. 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.

14. 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

15. Laffer Curve

16. 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