chapter 18 extending the analysis of aggregate supply copyright © 2015 mcgraw-hill education. all...
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Chapter 18
Extending the Analysis of Aggregate Supply
Copyright © 2015 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
18-2
From Short Run to Long Run
• Short run• Input prices inflexible• Upsloping aggregate supply
• Long run• Input prices fully flexible• Vertical aggregate supply
• The transition?
LO1
18-3
From Short Run to Long Run
• Production above potential output:• High demand for inputs• Input prices rise• Short run aggregate supply shifts left• Return to potential output
• Production below potential output• Graphical examples…
LO1
18-4
From Short Run to Long Run
P3
P1
P2
P3
P1
P2
Real Domestic Output Real Domestic Output
Qf
Short-RunAggregate Supply
Long-RunAggregate Supply
a1
a2
a3
b1
c1
Pric
e Le
vel
Pric
e Le
vel
AS3
AS2AS1ASLR
Qf Q2Q3
AS1
a1
a2
a3
LO1
18-5
From Short Run to Long Run
Real Domestic Output
Long Run EquilibriumPr
ice
Leve
l
P1
Qf
a
AS1ASLR
AD1
LO1
18-6
Extended AD-AS Model
Real Domestic Output
Demand-Pull Inflation Pr
ice
Leve
l
P1
Qf
a
AS1ASLR
AD1
AD2
AS2
c
bP2
P3
Q2
LO2
18-7
Extended AD-AS Model
Real Domestic Output
Cost-Push Inflation Pr
ice
Leve
l
P1
Qf
a
AS1ASLR
AD1
AD2
AS2
b
c
P2
P3
Q2
LO2
18-8
Extended AD-AS Model
Real Domestic Output
RecessionPr
ice
Leve
l P1
Qf
a
AS1ASLR
AD1AD2
AS2
b
c
P2P3
Q1
LO2
18-9
Extended AD-AS Model
• Explaining ongoing inflation• Ongoing economic growth shifts aggregate
supply • Ongoing increases in money supply shift
aggregate demand • Small positive rate of inflation
LO2
18-10
Pric
e Le
vel
Real GDP
Capi
tal G
oods
Consumer Goods
Productions Possibilities
Long Run Aggregate Supply
Increase in production possibilities
Increase in long-run aggregate supply
LO2
Economic Growth, Ongoing Inflation
18-11
P1
P2
Q2Q10
Pric
e le
vel
Real GDP
ASLR1 ASLR2
AS1
AS2
AD1
AD2
U.S. Growth
LO2
18-12
Inflation and Unemployment
• Low inflation and low unemployment rates• Fed’s major goals• Compatible or conflicting?
• Short-run tradeoff• Aggregate supply shocks cause both rates to
rise• No long-run tradeoff
LO3
18-13
The Phillips Curve
Real Domestic Output
Pric
e Le
vel
0
P0
P1
P2
P3
Q0 Q1 Q2 Q3
AD0
AD1
AD2
AD3
AS
LO3
18-14
0
1
2
3
4
5
6
7
0 1 2 3 4 5 6 7
Unemployment Rate (Percent)
An
nu
al
Ra
te o
f In
fla
tio
n (
Pe
rce
nt)
0
1
2
3
4
5
6
7
0 1 2 3 4 5 6 7An
nu
al
Ra
te o
f In
fla
tio
n (
Pe
rce
nt)
Unemployment Rate (Percent)
• Demonstrates short-run tradeoff between inflation and unemployment
69
68
6766
65
64
6362
61
Concept Empirical DataData for the 1960s
The Phillips Curve
LO3
18-15
The Phillips Curve
• 1960s economists believed in stable, predictable tradeoff
• Phillips curve shifts over time• Adverse supply shocks 1970s• OPEC oil price shock• Stagflation
• Stagflation’s demise 1980s
LO3
18-16
The Phillips Curve
• No long-run tradeoff between inflation and unemployment
• Short-run Phillips curve
• Role of expected inflation
• Long-run vertical Phillips curve
• Disinflation
LO4
18-17
The Phillips Curve
LO4
14
13
12
11
10
9
8
7
6
5
4
3
2
1
An
nu
al r
ate
of
infl
atio
n (
per
cen
t)
Unemployment rate (percent)
18-18
The Phillips Curve
The Misery Index, Selected Nations, 2001-2012
LO4
18-19
The Long-Run Phillips Curve
3 4 5 60
3
6
9
12
15An
nual
Rat
e of
Infla
tion
(Per
cent
)
Unemployment Rate (Percent)
PCLR
PC3
PC2
PC1
a1
b1
a2
a3
b2
b3
c3
c2
LO4
18-20
Taxes and Aggregate Supply
• Supply-side economics• Tax and incentives to work• Incentives to save and invest• The Laffer curve
Tax
Rate
(Per
cent
)
Tax Revenue (Dollars)
100
m
0
n
l
m
Laffer Curve
MaximumTax Revenue
LO5
18-21
Taxes and Aggregate Supply
• Criticisms of the Laffer curve• Taxes, incentives, and time• Inflation or higher real interest rates• Position on the curve
• Rebuttal and evaluation
LO5
18-22
Taxes and Real GDP
• New findings suggest tax increases reduce real GDP (Romer and Romer, 2008)
• Positive output shocks raise tax revenues• Difficult to separate the effects of tax changes
from other effects• Investment falls sharply in response to tax
changes
LO5
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