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Chapter 8 The New-Keynesian Theory of Aggregate Supply Introduction • - Great Depression Classical Model The neutrality of money Vertical AS - New-Keynesian Model - Sticky Price - Upward Slopped AS 2 The Classical and New-Keynesian Theories of Aggregate Supply Compared Figure 8.1A 3 ©2002 South-Western College Publishing The Classical and New-Keynesian Theories of Aggregate Supply Compared Figure 8.1B 4 ©2002 South-Western College Publishing The Theory of Nominal Rigidity • Two approaches: - The menu cost approach - The contract theory of wages Rigid nominal wages (This Chapter) 5 The Theory of Sticky Wages • The new-Keynesian theory of AS begins with the efficiency wage model and adds to it, assuming that the nominal wage is chosen less frequently than employment. • Employment contract The aggregate real wage may differ from the efficiency wage over long periods of time. 6 Unemployment and the Price Level when the Nominal Wage is Sticky 7 How Changes in the Price Level Affect Employment 8 ©2002 South-Western College Publishing How Changes in the Price Level Affect Employment 9 ©2002 South-Western College Publishing Aggregate Supply and the Price Level when the Nominal Wage is Sticky 10 The New-Keynesian Theory of Aggregate Supply Figure 8.3 11 ©2002 South-Western College Publishing Okun’s Law • Okun’s Law says that when unemployment increases by 1 percentage point, GDP will fall 3% below trend. • See BOX 8.2 12 From the Short Run to the Long Run 13 Getting from the Short Run to the Long Run Figure 8.4 14 ©2002 South-Western College Publishing The New-Keynesian Model and the Non-Neutrality of Money 15 The Non-Neutrality of Money in the Keynesian Model 16 Should We Stabilize the Business Cycle • The Real Business Cycle School - Most recessions are generated by fluctuations in the natural rate and that the mechanism that restores equilibrium is very fast. • Keynesians: - Some business cycles are not caused by changes in technology like the Great Depression. 17 Homework Question 4, 6, 7, 8 18 END