Lecture Economics (19/e) - Chapter 35: Extending the analysis of aggregate supply

35
Extending the Analysis of Aggregate Supply

McGraw­Hill/Irwin

        Copyright © 2012 by The McGraw­Hill Companies, Inc. All rights reserved.


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

35-2


From Short Run to Long Run

• Production above potential output:
• High demand for inputs
• Input prices rise
• Short run aggregate supply shifts
•
•
LO1

left
• Return to potential output
Production below potential output
Graphical examples…
35-3


From Short Run to Long Run
Short-Run
Aggregate Supply

Long-Run
Aggregate Supply

a2

P2
a1

P1
P3

a3
Q3

Qf

Q2

AS2

a2

b1

P2

AS1
AS3

a1

P1
P3

Real Domestic Output

LO1

ASLR
Price Level

Price Level

AS1

a3

c1

Qf

Real Domestic Output

35-4


From Short Run to Long Run
Long Run Equilibrium

Price Level

ASLR

AS1

a

P1

AD1

Qf
Real Domestic Output
LO1

35-5


Extended AD­AS Model

Demand-Pull Inflation

Price Level

ASLR

P3

AS1

c
b

P2
P1

AS2

a
AD2
AD1

Qf Q 2
Real Domestic Output

LO2

35-6

Extended AD­AS Model
Cost-Push Inflation

Price Level

ASLR

AS1

c

P3
P2

AS2

b
a

P1

AD2
AD1

Q2 Qf
Real Domestic Output

LO2

35-7

Extended AD­AS Model
Recession

Price Level

ASLR

P3

AS2

a

P1
P2

AS1

b
c
AD1
AD2

Q1 Qf
Real Domestic Output

LO2

35-8


Extended AD­AS Model

• Explaining ongoing inflation
• Ongoing economic growth shifts

•

LO2

aggregate supply
• Ongoing increases in money supply
shift aggregate demand
Small positive rate of inflation

35-9


Economic Growth, Ongoing Inflation

Consumer Goods

Increase in production
possibilities

LO2

Long Run

Aggregate Supply

Price Level

Capital Goods

Productions
Possibilities

Real GDP

Increase in long-run
aggregate supply

35-10


Inflation and Unemployment

• Low inflation and unemployment
• Fed’s major goals
• Compatible or conflicting?
• Short-run tradeoff
• Supply shocks cause both rates to
•
LO3

rise
No long-run tradeoff

35-11


The Phillips Curve

• 1960s economists believed in stable,
•
•
•
LO3

predictable tradeoff
Phillips curve shifts over time
Adverse supply shocks 1970s
• OPEC oil price shock
• Stagflation
Stagflation’s demise 1980s
35-12


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

35-13


The Phillips Curve

Annual rate of inflation (percent)

14
13
12
11
10
9
8
7
6
5
4
3
2
1

Unemployment rate (percent)
LO4

35-14


Taxes and Aggregate Supply

• Supply-side economics
• Tax incentives to work
• Tax incentives to save and invest
• The Laffer curve
Tax Rate (Percent)

100
n
m

LO5

m
l

0

Laffer Curve

Maximum
Tax Revenue

Tax Revenue (Dollars)
35-15


Taxes and Aggregate Supply

• Criticisms of the Laffer curve

• Taxes, incentives, and time
• Inflation and higher real interest
•

LO5

rates
• Position on the curve
Rebuttal and evaluation

35-16