Download From Short Run to Long Run

35
Extending the Analysis of Aggregate
Supply
McGraw-Hill/Irwin
Copyright © 2012 by The McGraw-Hill 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
Long-Run
Aggregate Supply 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 AD-AS Model
Demand-Pull Inflation
Price Level
ASLR
P3
AS1
c
b
P2
P1
AS2
a
AD2
AD1
Qf Q2
Real Domestic Output
LO2
35-6
Extended AD-AS Model
Cost-Push Inflation
Price Level
ASLR
AS1
c
P3
P2
AS2
b
a
P1
AD2
AD1
Q2 Q f
Real Domestic Output
LO2
35-7
Extended AD-AS Model
Recession
Price Level
ASLR
P3
AS2
a
P1
P2
AS1
b
c
AD1
AD2
Q1 Qf
Real Domestic Output
LO2
35-8
Extended AD-AS 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
U.S. Growth
ASLR1
ASLR2
AS2
Price level
AS1
P2
P1
AD2
AD1
0
Q1
Q2
Real GDP
LO2
35-11
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
35-12
The Phillips Curve
Price Level
AS
P3
P2
AD3
P1
P0
AD2
AD1
AD0
0
Q0 Q1 Q2 Q3
Real Domestic Output
LO3
35-13
The Phillips Curve
• Demonstrates short-run tradeoff between
inflation and unemployment
Concept
Empirical Data
7
6
5
4
3
2
1
0
0
1
2
3
4
5
6
Unemployment Rate (Percent)
LO3
7
Annual Rate of Inflation (Percent)
Annual Rate of Inflation (Percent)
Data for the 1960s
7
69
6
5
68
4
66
67
3
65
2
1
64
63
62
61
0
0
1
2
3
4
5
6
7
Unemployment Rate (Percent)
35-14
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
35-15
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
35-16
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
35-17
The Phillips Curve
The Misery Index, Selected Nations, 1999-2009
15
10
5
1999
2001
2003
2005
2007
2009
Source: Bureau of Labor Statistics,stats.bls.gov
LO4
35-18
The Long-Run Phillips Curve
PCLR
Annual Rate of Inflation (Percent)
15
PC3
12
b3
PC2
9
a3
b2
PC1
6
c3
a1
c2
b1
3
0
a2
3
4
5
6
Unemployment Rate (Percent)
LO4
35-19
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
Laffer Curve
m
l
Maximum
Tax Revenue
0
Tax Revenue (Dollars)
LO5
35-20
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
35-21
Taxes and Real GDP
• New findings suggest tax increases
•
•
•
LO5
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
35-22