Chapter 18: Extending the Analysis of Aggregate Supply

Extending the Analysis of Aggregate SupplyMcGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.From Short Run to Long RunShort runInput prices inflexibleUpsloping aggregate supplyLong runInput prices fully flexibleVertical aggregate supplyThe transition?LO1From Short Run to Long RunProduction above potential output:High demand for inputsInput prices riseShort run aggregate supply shifts leftReturn to potential outputProduction below potential outputGraphical examplesLO1From Short Run to Long RunP3P1P2P3P1P2Real Domestic OutputReal Domestic OutputQfShort-RunAggregate SupplyLong-RunAggregate Supplya1a2a3b1c1Price LevelPrice LevelAS3AS2AS1ASLRQfQ2Q3AS1a1a2a3LO1From Short Run to Long RunReal Domestic OutputLong Run EquilibriumPrice LevelP1QfaAS1ASLRAD1LO1Extended AD-AS ModelReal Domestic OutputDemand-Pull Inflation Price LevelP1QfaAS1ASLRAD1AD2AS2cbP2P3Q2LO2Extended AD-AS ModelReal Domestic OutputCost-Push Inflation Price LevelP1QfaAS1ASLRAD1AD2AS2bcP2P3Q2LO2Extended AD-AS ModelReal Domestic OutputRecessionPrice LevelP1QfaAS1ASLRAD1AD2AS2bcP2P3Q1LO2Extended AD-AS ModelExplaining ongoing inflationOngoing economic growth shifts aggregate supply Ongoing increases in money supply shift aggregate demand Small positive rate of inflationLO2Price LevelReal GDPCapital GoodsConsumer GoodsEconomic Growth, Ongoing InflationProductions PossibilitiesLong Run Aggregate SupplyIncrease in production possibilitiesIncrease in long-run aggregate supplyLO2Inflation and UnemploymentLow inflation and unemploymentFed’s major goalsCompatible or conflicting?Short-run tradeoffSupply shocks cause both rates to riseNo long-run tradeoffLO31960s economists believed in stable, predictable tradeoffPhillips curve shifts over timeAdverse supply shocks 1970sOPEC oil price shockStagflationStagflation’s demise 1980sThe Phillips CurveLO3The Phillips CurveNo long-run tradeoff between inflation and unemploymentShort-run Phillips curveRole of expected inflationLong-run vertical Phillips curveDisinflationLO4The Phillips CurveLO41413121110987654321Annual rate of inflation (percent)Unemployment rate (percent)Taxes and Aggregate SupplySupply-side economicsTax incentives to workTax incentives to save and investThe Laffer curveTax Rate (Percent)Tax Revenue (Dollars)100m0nlmLaffer CurveMaximumTax RevenueLO5Taxes and Aggregate SupplyCriticisms of the Laffer curveTaxes, incentives, and timeInflation and higher real interest ratesPosition on the curveRebuttal and evaluationLO5