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Second Step: Okun’s Law Okun’s Law where Note: We have found two relationship of three important variables output, inflation rate and unemployment. They are Phillips curve and Okun’s law. In addition, now introduce the concept of sacrifice ratio: the percentage of output lost for each 1 point reduction in the inflation rate. Final Step: Translation 1) Phillips curve 2) 3) Okun’s law Therefore Let , , we have or Summary in AS Curve We derive short run AS curve by translating. 1) The natural rate of unemployment 2) The Phillips curve 3) The Phillips curve with expected inflation 4) The long-run Phillips curve . 5) The AS curve or 6) Adaptive expectation and rational expectation Summary in AS Curve The short-run and long-run AS curve Y P AS Y* Application: Supply Shock Oil price shock P Y AS Y* AS1 Application: Supply Shock A favorable supply shock P Y AS Y* AS1 Application: Supply Shock A favorable supply shock: technological improvements P Y AS Y* AS1 P Y AS Y* AS1 Case 1 Case 2 Y** Y** Exercise: Solow Model and Unemployment Consider how unemployment would affect the Solow growth model. Suppose that output is produced according to the production function , where is capital, is the labor force, and is the natural rate of unemployment. The national saving rate is , the labor force grows at rate , and capital depreciates at rate . 1) Express output per worker ( ) as a function of capital per worker ( ) and the natural rate of unemployment. Describe the steady state of this economy. 2) Suppose that some change in government policy reduces the natural rate of unemployment. Describe how this change affects output both immediately and over time. Is the steady-state effect on output larger or smaller than the immediate effect? Explain. Key to 1) Key to 2) Key to 2) (Continued) Reference 王志伟译著，Rudiger Dornbusch, Stanley F