Aggregate Supply, Unemployment and Inflation
Aggregate Supply, Unemployment and Inflation
Aggregate Supply
AGGREGATE SUPPLY Different views on the shape of the AS curve
Contrasting views on the aggregate supply curve: (a) Extreme Keynesian AS
P
Contrasting views on the aggregate supply curve: (a) Extreme Keynesian AS
P
AD Y
Y
Contrasting views on the aggregate supply curve: (a) Extreme Keynesian AS
P
AD AD Y
Y
Y
Contrasting views on the aggregate supply curve: (b) Extreme Monetarist / New Classical AS
Y
Contrasting views on the aggregate supply curve: (b) Extreme Monetarist / New Classical AS
P
AD Y
Contrasting views on the aggregate supply curve: (b) Extreme Monetarist / New Classical AS
P
P
AD AD Y
Contrasting views on the aggregate supply curve: (c) Moderate view
AS
Contrasting views on the aggregate supply curve: (c) Moderate view
AS
P
AD Y
Contrasting views on the aggregate supply curve: (c) Moderate view
AS
P P
AD AD Y
Y
AGGREGATE SUPPLY Different views on the shape of the AS curve Short-run aggregate supply
AGGREGATE SUPPLY Different views on the shape of the AS curve Short-run aggregate supply the microeconomic foundations
Short-run response of a profit-maximising firm to a rise in demand MC
P1
AR Q
MR
Q
Short-run response of a profit-maximising firm to a rise in demand MC
P1
AR Q
MR
MR
AR
Q
Short-run response of a profit-maximising firm to a rise in demand MC
P2 P1
AR Q Q
MR
MR
AR
Q
The short-run aggregate supply curve AS
P P P
AD AD
AD Y
Y
Y
AGGREGATE SUPPLY Different views on the shape of the AS curve Short-run aggregate supply the microeconomic foundations
Long-run aggregate supply
AGGREGATE SUPPLY Different views on the shape of the AS curve Short-run aggregate supply the microeconomic foundations
Long-run aggregate supply the interdependence of firms
The long-run AS curve when firms are interdependent AS
AS AS
c b a
AD AD
AGGREGATE SUPPLY Different views on the shape of the AS curve Short-run aggregate supply the microeconomic foundations
Long-run aggregate supply the interdependence of firms investment
Effect of investment on the long-run AS curve AS
a
AD
Effect of investment on the long-run AS curve AS AS b
AS d
a
AD AD
AGGREGATE SUPPLY Different views on the shape of the AS curve Short-run aggregate supply the microeconomic foundations
Long-run aggregate supply the interdependence of firms investment expectations
AGGREGATE SUPPLY LRAS: monetarist / new classical model flexible real wage rates
The aggregate labour market: Monetarist / New Classical analysis
AS
W/P
N
a W
b
AD Q
The aggregate labour market: Monetarist / New Classical analysis
AS
W/P
N
a W
b
AD Q
The aggregate labour market: Monetarist / New Classical analysis
AS
W/P
N
a W W
b
W W
AD Q
The aggregate labour market: Monetarist / New Classical analysis
AS
W/P
N
a W W
c
b d
d−c. W
AD Q
AGGREGATE SUPPLY LRAS: monetarist / new classical model flexible real wage rates no money illusion
AGGREGATE SUPPLY LRAS: monetarist / new classical model flexible real wage rates no money illusion natural level of unemployment
The aggregate labour market: Monetarist / New Classical analysis
AS
W/P
N
a W
b
AD Q
AGGREGATE SUPPLY LRAS: monetarist / new classical model flexible real wage rates no money illusion natural level of unemployment implications for shape of LRAS
LRAS: Keynesian models
AGGREGATE SUPPLY LRAS: monetarist / new classical model flexible real wage rates no money illusion natural level of unemployment implications for shape of LRAS
LRAS: Keynesian models wage and price rigidity
Keynesian analysis of the aggregate labour market: fall in ADL
AS
W/P
N
c
a
W
b
AD Q
Q
AD
AGGREGATE SUPPLY LRAS: monetarist / new classical model flexible real wage rates no money illusion natural level of unemployment implications for shape of LRAS
LRAS: Keynesian models wage and price rigidity hysteresis
Keynesian analysis of the aggregate labour market: hysteresis
AS
W/P
N
c
a
W
b ADAD
AD Q
Q
AD
Keynesian analysis of the aggregate labour market: hysteresis
AS
AS N
W/P
d W
c
e a
W
b AS
AD Q
Q
AD
AGGREGATE SUPPLY LRAS: monetarist / new classical model flexible real wage rates no money illusion natural level of unemployment implications for shape of LRAS
LRAS: Keynesian models wage and price rigidity hysteresis expectations of output changes
AGGREGATE SUPPLY LRAS: monetarist / new classical model flexible real wage rates no money illusion natural level of unemployment implications for shape of LRAS
LRAS: Keynesian models wage and price rigidity hysteresis expectations of output changes long-run money illusion
AGGREGATE SUPPLY AS, AD and inflation demand-pull inflation
Demand-pull inflation
AS
P
d
P P P
AS
c b a AD AD AD
Demand-pull inflation
AS
P P
e d
P P P
AS
c b a AD AD AD AD
Demand-pull inflation AS AS P
f
P P
d
e
P P P
AS
c b a AD AD AD AD
Demand-pull inflation AS g
P P
f
P P
d
AS
e
P P P
AS
c b a
AD AD AD AD AD
AGGREGATE SUPPLY AS, AD and inflation demand-pull inflation cost-push inflation
Cost-push inflation AS AS
P P P P
AS
d c b a
AD AD
Cost-push inflation AS AS AS
P P P P P
AS
e d c b a
AD AD
AGGREGATE SUPPLY AS, AD and inflation demand-pull inflation cost-push inflation what causes inflation in practice?
Aggregate Supply, Unemployment and Inflation
Expectations Augmented Phillips Curve
EXPECTATIONS AUGMENTED PHILLIPS CURVE Incorporating expectations into a Phillips equation Adaptive expectations The accelerationist theory attempting to reduce unemployment below the ‘natural’ level
.
P
The accelerationist theory of inflation
b a . IP
U
.
P
The accelerationist theory of inflation
f e d . IV Pe
b
c
.
III Pe
.
a
II Pe
.
I Pe
U
EXPECTATIONS AUGMENTED PHILLIPS CURVE Incorporating expectations into a Phillips equation Adaptive expectations The accelerationist theory attempting to reduce unemployment below the ‘natural’ level the long-run Phillips curve
.
P
The long-run Phillips curve
U U
EXPECTATIONS AUGMENTED PHILLIPS CURVE Incorporating expectations into a Phillips equation Adaptive expectations The accelerationist theory attempting to reduce unemployment below the ‘natural’ level the long-run Phillips curve effects of deflationary policies
.
P
The effects of deflation
J
k
.
X Pe
U
.
P
The effects of deflation
J
k l m
.
X Pe
.
XI Pe
.
XII Pe
U
.
P
The effects of deflation
J
k l m
a
U
EXPECTATIONS AUGMENTED PHILLIPS CURVE How quickly can inflation be eliminated? the ‘short, sharp shock’ the slow route
Explanations of stagflation clockwise Phillips loops
.
P
Clockwise Phillips loops
c
b a U
U
.
P
Clockwise Phillips loops
f
e d
c
b a U
U
.
P
Clockwise Phillips loops
f
e
g
d
h c i b a U
J
U
EXPECTATIONS AUGMENTED PHILLIPS CURVE How quickly can inflation be eliminated? the ‘short, sharp shock’ the slow route
Explanations of stagflation clockwise Phillips loops rightward shifts in the long-run Phillips curve
EXPECTATIONS AUGMENTED PHILLIPS CURVE How quickly can inflation be eliminated? the ‘short, sharp shock’ the slow route
Explanations of stagflation clockwise Phillips loops rightward shifts in the long-run Phillips curve
Policy implications of the model
EXPECTATIONS AUGMENTED PHILLIPS CURVE How quickly can inflation be eliminated? the ‘short, sharp shock’ the slow route
Explanations of stagflation clockwise Phillips loops rightward shifts in the long-run Phillips curve
Policy implications of the model shifting the long-run Phillips curve
Phillips loops in the UK? 75
80
76 74
77 79 81
7 3
90
7 1
78
7 2
82
89 91 88
00
98
01 02
97
95 96
99
85
94
87 92 93
86
84
83
Phillips loops in the UK? 75
80
76 74
77 79 81
7 3
90
7 1
78
7 2
82
89 91 88
00
98
01 02
97
95 96
99
85
94
87 92 93
86
84
83
Phillips loops in the UK? 75
80
76 74
77 79 81
7 3
90
7 1
78
7 2
82
89 91 88
00
98
01 02
97
95 96
99
85
94
87 92 93
86
84
83
Phillips loops in the UK? 75
80
76 74
77 79 81
7 3
90
7 1
78
7 2
82
89 91 88
00
98
01 02
97
95 96
99
85
94
87 92 93
86
84
83
Phillips loops in the UK? 75
80
76 74
77 79 81
7 3
90
7 1
78
7 2
82
89 91 88
00
98
01 02
97
95 96
99
85
94
87 92 93
86
84
83
Phillips loops in the UK? 75
80
76 74
77 79 81
7 3
90
7 1
78
7 2
82
89 91 88
00
98
01 02
97
95 96
99
85
94
87 92 93
86
84
83
Aggregate Supply, Unemployment and Inflation
Rational Expectations and the Phillips Curve
RATIONAL EXPECTATIONS AND THE PHILLIPS CURVE Assumptions flexible wages and prices rational expectations
Aggregate supply & the Phillips curve: when expectations are correct short-run vertical AS curve
The effects of an increase in aggregate demand
SRAS P
P
b
(a) Adaptive expectations
P a
AD AD Q
Q
The effects of an increase in aggregate demand SRAS P
SRAS P
c
P P
b
(a) Adaptive expectations
P a
AD AD Q
Q
The effects of an increase in aggregate demand LRAS SRAS P
SRAS P
c
P P
b
(a) Adaptive expectations
P a
AD AD Q
Q
The effects of an increase in aggregate demand
SRAS P
(b) Rational expectations P a
AD AD Q
The effects of an increase in aggregate demand SRAS P
SRAS P
c P
(b) Rational expectations
P a
AD AD Q
The effects of an increase in aggregate demand LRASSRAS SRAS P
SRAS P
c P
(b) Rational expectations
P a
AD AD Q
RATIONAL EXPECTATIONS AND THE PHILLIPS CURVE Assumptions flexible wages and prices rational expectations
Aggregate supply & the Phillips curve: when expectations are correct short-run vertical AS curve short-run vertical Phillips curve
RATIONAL EXPECTATIONS AND THE PHILLIPS CURVE Aggregate supply & the Phillips curve: when expectations are incorrect the goods market
How a rise in aggregate demand could cause a rise in national output LRAS SRAS P
b
P
SRAS P
P P a
AD AD Q
Q
AD
How a rise in aggregate demand could cause a fall in national output LRAS
SRAS P
SRAS P
P P
c
P a
AD AD AD Q Q
RATIONAL EXPECTATIONS AND THE PHILLIPS CURVE Aggregate supply & the Phillips curve: when expectations are incorrect the goods market the labour market
Effects in the labour market of an underprediction of inflation ASW / P W / P
W/
ASW / PW / P
Underprediction
AD Q
Q
RATIONAL EXPECTATIONS AND THE PHILLIPS CURVE Aggregate supply & the Phillips curve: when expectations are incorrect the goods market the labour market implications for the Phillips curve
Policy implications of rational expectations Real business cycles persistent shifts in aggregate supply turning points
New classical version of short-run Phillips curves . . P
. . P =P
. . P >P
RATIONAL EXPECTATIONS AND THE PHILLIPS CURVE Aggregate supply & the Phillips curve: when expectations are incorrect the goods market the labour market implications for the Phillips curve
Policy implications of rational expectations
RATIONAL EXPECTATIONS AND THE PHILLIPS CURVE Aggregate supply & the Phillips curve: when expectations are incorrect the goods market the labour market implications for the Phillips curve
Policy implications of rational expectations Real business cycles
RATIONAL EXPECTATIONS AND THE PHILLIPS CURVE Aggregate supply & the Phillips curve: when expectations are incorrect the goods market the labour market implications for the Phillips curve
Policy implications of rational expectations Real business cycles persistent shifts in aggregate supply
RATIONAL EXPECTATIONS AND THE PHILLIPS CURVE Aggregate supply & the Phillips curve: when expectations are incorrect the goods market the labour market implications for the Phillips curve
Policy implications of rational expectations Real business cycles persistent shifts in aggregate supply turning points
Aggregate Supply, Unemployment and Inflation
Modern Keynesian Views
MODERN KEYNESIAN VIEWS Modern developments of the Keynesian model Growth in equilibrium unemployment higher structural unemployment hysteresis
The persistence of demand-deficient unemployment payment of efficiency wages insider power
MODERN KEYNESIAN VIEWS Incorporation of expectations expansion of aggregate demand
Keynesian analysis of reflationary policies
.
c
P
Z
b
.
a
P
II I
U
U
MODERN KEYNESIAN VIEWS Incorporation of expectations expansion of aggregate demand contraction of aggregate demand
Keynesian analysis of deflationary policies
a
U
b
U
I
Keynesian analysis of deflationary policies
a
b c
U
U
I
MODERN KEYNESIAN VIEWS Incorporation of expectations expansion of aggregate demand contraction of aggregate demand
Keynesian criticisms of non-intervention
Aggregate Supply, Unemployment and Inflation
Common Ground Among Economists?
COMMON GROUND AMONG ECONOMISTS? Short-run effects of changes in aggregate demand Long-run effects of changes in aggregate demand Role of expectations Importance of supply-side factors