Unit 5 notes

Short Run AS

• Time is too short for wages to adjust to the price level 
• Workers may not be aware of changes in their real wages due to inflation and have adjusted their labor decisions and wage demands accordingly. 
• Nominal Wages: Amt. of money received per hour, day, or year
• Adjusted for inflation
• Sticky Wage: Nominal wage level set according to an initial price level and it does not vary.
• Will be stuck in the short run for a while

Price level	Wage level	Employment level	Implications
Keynesian: Fixed	Fixed	Flexible	Output depends on changes in employment
Intermediate: flexible	Fixed	Flexible	Output depends on change in price level and employment
Classical: flexible	Fixed	Fixed	Output depends on a change in price level

Long Run AS

• It has flexible wages and price levels
• off set each other
• Time is long enough for wages to adjust to price level
• if we have growth, capital stock gain and change in technology.

Phillips Curve

• Represents the relationship between inflation and unemployment. 
• Trade off between inflation and unemployment only occurs in the short run.

Long Run

• The long run curve occurs at the natural rate of unemployment
• represented by a vertical line
• there is no trade off in the long run, meaning the economy produces at full employment level
• Long run Philips Curve shift only if LRAS shifts
• At the natural rate of unemployment: structural, seasonal and frictional unemployment exist
• fewer worker benefits create lower natural rates
• Shift PPC outwards, LRPC will shift, otherwise it is vertical and stable

Short run

• Inverse relationship between inflation & unemployment.
• High inflation means lower employment
• Relevance to okun's law
• Since wages are sticky
• inflation changes
• moves the points on SRPC
• If inflation persist and expected rate of inflation rises, then the entire SRPC moves upward due to stagflation.  
• If inflation drop due to new technology or economic growth then SRPC moves downward
• Aggregate supply shock cause both rate of inflation & unemployment to inc. 
• Supply shock
• rapid and significant inc. in resource cost.

• Misery index
• combination of inflation & unemployment in any given year. 
• Single digit misery is good.
• LRPC: exist natural rate of unemployment, structural changes in the economy affect unemployment and shift LRPC

• Stagflation: when inflation/unemployment increase simultaneously

1. During 1946-1964 (baby boom)
2. Women's movement
3. Civil rights movement
4. Vietnam War ends
5. Oil embargo 1973 & 1979

• Disinflation: reduction in inflation rate from year to year. 
• occurs when AD declines.
• Deflation: general drop in the price level.

Supply Side Economics

• Belief that as AS curve determine level of inflation, unemployment, & econ growth.  
• To increase economy,  the AS curve will have to shift to the right which will have to benefit the economy first.
• Supply Side Economics focus more on marginal tax rate.
• marginal tax rate = amount paid on last dollar earned or additional dollar earned
• Lower taxes are incentives for businesses to invest in our economy. 
• Lowered taxes are incentives to increase savings & therefore create lower interest rates which will increase business investment.

Supply Side Economists support policies that promote GDP growth by arguing high marginal tax rate along with the current system of transfer payments, such as welfare and unemployment provide disincentives to work, invest and undertake entrepreneurial ventures.

• Referred to as Reaganomics
• Lower marginal tax rate to get U.S. out of a recession >  deficit. 
• Trade off between tax rates & govt. revenue is used to support supply side argument.  
• As tax rates increase from zero, tax revenue increase from zero to some maximum level and then declines.

3 criticism of the Laffer Curve:

1. Research suggests that impact of tax rates on incentives to work, invest, & to save are small.
2. Tax cut also increase demands which can fuel inflation & cause demand to exceed supply.
3. Where economy actually located on the curve is get to be determined.