LS6.pptVIP

Summary implications Each of the three models of agg. supply imply the relationship summarised by the SRAS curve  equation Y P LRAS SRAS Over time, P e rises, SRAS shifts up,and output returns to its natural rate. Summary implications Suppose a positive AD shock moves output above its natural rate and P above the level people had expected. Y P LRAS SRAS1 SRAS2 AD1 AD2 The Phillips Curve A.W. Phillips 1958 highlighted the negative relationship between the unemployment rate and the rate of wage inflation in UK data. Modern versions of the Phillips curve state the relationship in terms of cyclical unemployment, u - un , and unexpected general inflation, ? - ?e : the negative relationship between cyclical unemployment and unexpected inflation NB. natural rate of unemployment is unemployment when the economy is at its natural rate of output i.e. Frictional unemployment Deriving the Phillips Curve from SRAS The Phillips Curve and SRAS SRAS curve: output is related to unexpected movements in the price level Phillips curve: unemployment is related to unexpected movements in the inflation rate i.e. there is a short-run trade-off between inflation and unemployment The sacrifice ratio measures the percentage of real GDP that must be foregone to reduce inflation by 1% Graphing the Phillips curve In the short run, policymakers face a trade-off between ? and u. u ? The short-run Phillips Curve ?e * The natural rate hypothesis allows us to study the long run separately from the short run. Aggregate Supply and the Phillips Curve Classical and Keynesian AS Y P AS Classical AS: Y P AS Keynesian fixed-price AS: Y natural rate of output A Initial equilibrium at A AD shifts to AD2 In the short run, prices don’t change, output expands Economy is at B In the long run, prices change, output goes back to natural rate Economy is at C Y P SRAS SR and LR Effects of a Change in AD LRAS AD AD2 B C Y 3 Alternative Models of AS New Keynesian models: