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long run aggregate supply is

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the vertical line at full employment

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Long run aggregate supply is the same thing as

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ppc curve

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Factors that increase economic growth

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increase resources, better resource quality, techniological advances

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Short run (SRAS)

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a period in which nominal wages (input costs) remain fixed as price level (profits) increase or decrease

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Long Run (LRAS)

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a period in which nominal wages are fully responsive to price level changes

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Reasons why wages are fixed in SR

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workers don't realize that inflation is increasing and under fixed-wage contract

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As LRAS shifts to right

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it drags AD curve with it-- increasing price levels

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When price level change is anticipated

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equilibrium is the same for both SRAS and LRAS curve and FE

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But when inflation(increase in pl) is unanticipated

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output prices(profits) increase in the short run and then moves to long run

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More profits cause

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the law of supply to kick in- Firms will attempt to increase quantity supplied--offer workers overtime, entice new workers to come in to labor force- this over extends the economy and cause DEMAND PULL INFLATION

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An increase in quantity supply is shown as

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moving up the fixed AS curve

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In the long run workers will

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realize wages have decline because of increase in prices- demand raise in wages and restore previous level of purchasing power

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This trend of inflation and wages are the reason why price levels

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are continually increasing

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In the extended as/ad model in the short run there is a trade off between

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rate of inflation and unemployment rate

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Aggregate supply shocks(cost push inflation/stagflation) cause

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higher rates of inflation and higher rates of unemployment

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In the long run there is

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no significant trade off between inflation and unemployment

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High inflation is accompanied

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by low employment

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Phillips Curve

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demonstrates the trade off between inflation and unemployment-- mirror image of as/ad

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On the phillips curve AD is

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a vampire--invisible

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Short run Phillips Curve (SRPC) is

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an inverse of the SRAS curve

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During 1970 and 1980s stagflation (inflation and umemployment) rose this proves

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AS shocks can cause both higher inflation and higher unemployment

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Chairman of FED

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Paul Volker

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What did Paul volker do?

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followed a tight money policy aimed at reducing inflation by 1983 inflation was under control and IG was increasing--AD was too

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When nominal wages are finally eaten up

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profits will fall ending the stimulus to produce beyond FE

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Like LRAS the LRPC

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is a straight line at the natural rate of full employment

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In the terms of aggreagte supply a period in which nominal wages and other inputs are constant is called

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short run

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In the terms of aggreagte supply, a period in which nominal wages and other inputs prices are variable is called

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long run

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In the extended analysis aggregate supply, the

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short run is curve upward sloping and the long run is vertical line

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Long run aggregate supply curve is vertical because

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resource prices eventually rise and fall with product prices

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the short run aggregate supply is sloping because

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higher price levels create incentives to expand output when resource prices are unresponsible to Price level change

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An increase in the price level will cause

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a movement up along the short run aggregate supply curve

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a decrease in price level will cause

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a movement on aggregate supply curve

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In the short run as/ad , cost push inflation would be best shown as a

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leftward shift of aggreagate supply

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Cost push inflation

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increase in prices--pushes short run aggregate supply left

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Demand pull inflation

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aggregate demand exceeds aggregate supply--up along short run curve

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Stagfaltion

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high unemployment and high inflation

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A major adverse aggregate supply side shock cause

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the phillips curve moves up and to the write

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a aggregate supply shocks could result from

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a rapid price in oil prices

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an aggregate supply shock could cause

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stagflation

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in the long run there is no

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trade off between inflation and unemployment

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when the actual rate of inflation exceeds the expected rate firms will experience

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rising profits and thus increasing their employment

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supply side economist stress that shifts in AS

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are the main deteriemants for inflation rates, unemployment, and GDP growth

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Supply siders argue that high marginal tax rates

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serverly discourage work, savings, and investment

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supply side economist argue large reduction in personal and corporate income taxes will

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increase aggregate supply mcuh more than AD

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laffer curve is relationship

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between tax rates and tax revenues

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if goverment collected 100% of tax rate there would be no

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incentive to work

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Critism of Supply side

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1.The relationship between tax rate and economic incentives is small and uncertain 2.Tax cuts can be more stimulating to AD that AS causing demand-pull inflation 3. It is not clear where max tax rate level is located

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Public debt

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is the total accumlation of years past deficits minus surpluses the federal goverment has incured through time

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Federal deficit budget is found by

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subtracting goverment tax revenues from goverment spending in a particular year

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Public debt is held by

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treasury bills, treasury notes, treasury bonds, and US savings bond

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Factors that cause public debt

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war, recession, tax cuts(biggest since 80s)

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Debts to GDP ratio

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a wealthy, highly productive nation can incur and carry more debt--more meaningful to measure the national debt in relation to our GDP

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Interest payments

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the primary burden of the debt is the annual interest rate charged on the debt-- now the fourth largest item on the federal budget--75% of debt is owned by americans it goes back to into us economy

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False concern about debt-- Bankruptcy

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goverment will never go bankrupt bc it can print money, taxation,and refinancing(selling and buying bonds)

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False concern about debt--burdening future generation

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since 75% of debt is owned by americans it is a liabitily to americans and an asset to american investors-- only the foriegn debt would negatively impact purchasing power

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Real concerns about debt- Income distribution

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Most of the ownership of the public debt is concentrated among the wealthier americans. Paying off debt would transfer income from lower income taxpayers to high income people increasing nations income inequalities

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Real concerns about debt- incentives

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as debt grows bigger interest paid on it will grow. goverment spending must be cut or taxes must increase to pay that interest

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Real concerns-foriegn owned public debt

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interest payment to debt owners outside the us allows forigeners to buy some of our economic output

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Real concerns--large public debt leads to

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higher interest rate which reduces IG

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The most likely way the public debt burdens future generation if at all is by

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reducing the current level of goverment investments

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Budget Philosophies-- Annual Balanced Budget

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a balanced budget amendment would require decreased goverment spending or increase in taxation in recessionary periods. If goverment adheared strictly to annually balanced budget the goverments budget would intesify the business cycle

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Budget Philosophies--Cyclically Balanced Budget

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run deficits in recessions and surpluses during expansionary so the budget is balanced not each year but each business cycle. Major critism against this is upswings and downswings of business cycle are not always equal in magnitude and direction

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Budget Philosophies--Functional Finance

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balance the economy not the budget. Views the public budget primarily as a way to stabilize economy. Deficitys are minor problems, compared to inflation or recession

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The basic problem portrayed by traditional phillips curve is that levels of aggreagate demand sufficently high to result in full employment may cause

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high inflation

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A rightward shift of phillips curve would suggest that the

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rate of inflation is now higher at each rate of umemployment

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a major adverse aggregate supply shock causes

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phillips curve to shift to the right

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Aggreagte supply shock worsen

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inflation and unemployment

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The equation underlying mainstream macroeconmics is

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C+Ig+G+X

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According to mainstream economists US macro instablitly resulted from

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booms and bust and ocassionally aggregate supply shocks

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the economist that is most closey associated with monetarism

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Milton Freidmans

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Acording to moentarist changes in money supply are the primary cause of

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changes in real output and price level

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the basic equation of monetarism is

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MV=PQ (equation of exchange)

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In the equation of exchange the level of aggregate expenditures is indicated by

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real output(MV)

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According to the equation of exchange, changes in money supply can affect both

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both price level and physical volume of all goods and services produced

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Velocity is

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the number of times per year the average dollar is spent on final good and services

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At equilibrium level of GDP

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MV= Nominal GDP

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The equation of exchange suggest that if the supply and velocity of money remain unchanged, an increase in the physical volume of goods and services produced will cause a

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decrease in price level or increase in GDP

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Monetarist believe that private economy is inhertanitly stable and that the goverment sector should

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not interfere with economy

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According to monetarist, the great depression in the US largely resulted from

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goverment let money supply fall by 40%

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According to real business cycle theory recessions result from declines in

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LRAS rather than decreases in AD

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In the real business cycle theory recessions result from

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declines in AD thus decreasing ms

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Cordination failures

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the idea that an economy can get stuck in inflation/unemployment equilibrium

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Cordination failures is a

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self-fulling prophesy

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New classical economist hold that, left alone the economy

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will gravitate to its full employment level of output

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the rational expectation theory expects people to behave rationally and that all prices and products are

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flexible up and down

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Rational expectations theroy applies that the

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long run aggregate supply curve is vertical

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Mainstream economist queston the new classical assumption that

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wages and prices are equally flexible upward and downward

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According to mainstream view if prices are inflexible downward a decrease in aggregate demand will reduce

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real output, but not the price level

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Efficiency wage is a

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above-market wage

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If firms are paying efficiency wages they may be relcutant to

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cut wages when AD declines

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In the insider-outsider theory insiders are workers who

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retain employment during recession

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The traditional monetary rule is the idea that the annual rate of increase in the money supply should equal

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the potential annual growth rate of GDP

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The crowding out effect refers to the posibilty that deficit financing will increase

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interest rates and reduce investments

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In long run wages follow

answer

inflation

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In short run profits follow

answer

output/pl/GDP

Econ unit 7 – Flashcards

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