Aggregate Supply, Unemployment And Inflation

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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

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