Summary
Macroeconomics Week 7 summary
- Course
- Institution
Macroeconomics Week 7 summary with readings
[Show more]
Seller
Followapollinecroc
Reviews received
Content preview
Week 7:Preparation: Chap 14: Aggregate Supply and the
Short-Run
Tradeoff between Inflation and
Unemployment.
Real world compares to basic model: Aggregate supply curve is upward sloping
rather than vertical.
Y = Y + (P – EP), with > 0, Y is output, Y is the natural level of output, P is
the
price level, EP is the excepted price level.
indicates how much output responds to unexpected changes in the price level;
1/ is the slope of the aggregate supply curve.
If the price level is higher than the excepted price level, output exceeds its
natural level. If the price level is lower than the expected price level, output falls
short of its natural level.
Long-run monetary neutrality and short-run monetary non-neutrality are
perfectly compatible.
2 goals of the policy makers: low inflation and low unemployment but can
conflict. Tradeoff between inflation and unemployment is referred as Phillips
curve.
What determines excepted inflation? Plausible assumption: people form their
expectations of inflation based on recently observed inflation => Adaptive
expectations.
If people expect prices to rise this year as the same rate as they did last year: Eπ
= π—1
Then Phillips curve equation would be: π = π-1 -
(u – un) +
So inflation depends on past inflation, cyclical unemployment, and a supply
shock.
Here, natural rate of unemployment is called non-accelerating inflation rate of
unemployment, or NAIRU.
π—1 implies that inflation has inertia (keeps moving unless something acts to stop
it).
Robert Solow : “Why is our money ever less valuable? Perhaps it is simply that
we have inflation because we expect inflation, and we expect inflation because
we’ve had it.”
(u – un) shows that cyclical unemployment – the deviation of unemployment
from its natural rate- exerts upward or downward pressure on inflation.
, Low unemployment pulls the inflation rate up, called demand-pull inflation –
because high aggregate demand is responsible for this type of inflation.
measures how responsive inflation is to cycle unemployment.
shows that inflation also rises and falls because of supply shocks. An adverse
supply shocks implies a positive value of and causes inflation to rise => cost-
push inflation – adverse supply shocks are typically events that push up the cost
of production.
Unemployment is at its natural rate for u = un, and then π = Eπ + => short run
Phillips curve.
Sacrifice ratio: the percentage of a year’s GDP that must be forgone to reduce
inflation by 1% point.
Cold turkey solution to inflation: for example, a rapid disinflation would lower
output by 10 percent for two years.
Because the expectation of inflation influences the short-run trade off between
inflation and unemployment, we assume that people have rational expectations:
people optimally use all the available information including information about
current government policies, to forecast the future.
Chap 15: A Dynamic Model of Aggregate Demand and
Aggregate Supply.
Robert Lucas: “As an advice-giving profession, we are in a way over our heads”.
Economists need to pay more attention to the issue of how people form
expectations of the future.
Traditional methods of policy evaluation – such as those that rely on
standard macroeconometric models – do not adequately take into account
the impact of policy on expectations.
Lucas Critique
Some economists argue that policy maker policymakers should learn to live with
inflation, rather than incur the large cost of reducing it.
Two lessons:
The narrow lesson: economists evaluating alternative policies need to
consider how policy affects expectations and behavior.
The broad lesson is that policy evaluation is hard, so economists engaged
in this task should be sure to show the requisite humility.
Lecture: The AD-AS model, the Phillips curve, and the
Lucas Critique.
The model of Aggregate Demand and Aggregate Supply (the AD-AS model):
Link between short run neoclassical business cycle theory and long run
classical theory:
o Combines the AD-curve with a short-run AS curve.
o Determines Pt and Yt in the short run.
The benefits of buying summaries with Stuvia:
Guaranteed quality through customer reviews
Stuvia customers have reviewed more than 700,000 summaries. This how you know that you are buying the best documents.
Quick and easy check-out
You can quickly pay through credit card or Stuvia-credit for the summaries. There is no membership needed.
Focus on what matters
Your fellow students write the study notes themselves, which is why the documents are always reliable and up-to-date. This ensures you quickly get to the core!
Frequently asked questions
What do I get when I buy this document?
You get a PDF, available immediately after your purchase. The purchased document is accessible anytime, anywhere and indefinitely through your profile.
Satisfaction guarantee: how does it work?
Our satisfaction guarantee ensures that you always find a study document that suits you well. You fill out a form, and our customer service team takes care of the rest.
Who am I buying these notes from?
Stuvia is a marketplace, so you are not buying this document from us, but from seller apollinecroc. Stuvia facilitates payment to the seller.
Will I be stuck with a subscription?
No, you only buy these notes for $4.42. You're not tied to anything after your purchase.
Can Stuvia be trusted?
4.6 stars on Google & Trustpilot (+1000 reviews)
67096 documents were sold in the last 30 days
Founded in 2010, the go-to place to buy study notes for 14 years now