Economics: Unit 5 and 6

Short run

Time to short for wages to adjust to price level

Workers may not be aware of changes in their real wages due to inflation, therefore they have adjusted their labor supply decisions and wage demands accordingly

	Price level	Wage Level	Employment Level	Implications
Keynesian/Horizontal	Fixed	Fixed	Flexible	Output depends upon change in employment
Intermediate Range	Fixed	Fixed	Flexible	Output depends upon changes in the price level and employment
Vertical/Classical	Flexible	Flexible	Fixed	Output depends upon changes in price level

Long run

Time long enough for wages to adjust tot he Price Level 

Key assumptions

• Wage and price level
• Changes in price and wage outset one another
• Represented by a vertical line

graph of demand poll inflation; cost push inflation; Recession; economic

Recession Graph

Recession: Employment decreases

Demand Pull: Employment increases


Phillips Curve: Inverse relationship between inflation and unemployment

• Inflation expectation are held constant

If inflation persists and the expected inflation rises, then the entire SRPC (short-run Phillips curve) moves upward

• Stagflation is possible

If inflation expectations drops such as new technology, then the SRPC will move downward

• Graph of SRPC is moving

Increase in AD=Up/lift movement along SRPC (from a to b)

Decrease in AD=Down/right movement along SRPC (frm a to c, or b to c)

The long run Phillips curve can only change by the unemployment rate

Sources of long-run growth: 

• Productivity-Output per unit of worker
• Labor Productivity-Output per worker

Conditions for Growth

• Rule of Law
• Sound, legal and economic institutions
• Economic Freedom
• Respect for private property
• Political and economic stability
• Willingness to sacrifice current consumption in order to grow
• Saving 
• Trade

What leads to higher productivity?

• Stock of Physical Capital – buildings, machines, robots, etc.
• Human Capital – Knowledge, skills, educations, etc.
• Technology – technical means for producing goods and services
• Improved Resource Allocation – Trade allows us to shift labor services from low-productive jobs to high productive jobs.
• Economies of Scale – reductions in per-unit cost that result from increases in the size of markets and firms.

Production Possibilities Curve and LRAS:

• Economic Growth = Shift in Production Possibilities Curve outward
• Economic Growth = Shift in the Long-Run Aggregate Supply Curve to the RIGHT

The natural rate of unemployment is held constant


Major LRPC assumption is that more worker benefits create higher natural rate and fewer benefits erase lower natural rights of unemployment


Why Growth Rates Differ among Countries:

• Rates of Savings
• Foreign Investment
• Education
• Infrastructure – roads, power lines, ports, and information networks, etc.
• Research and Development
• Political Stability
• Protection of Property Rights
• Economic Freedom versus Excessive Government Intervention

Hindrances to Growth:

• Economic and Political Instability
• High inflationary expectations
• Absence of the rule of law
• Diminished Private Property Rights
• Negative Incentives
• The welfare state
• Lack of Savings
• Excess current consumption
• Failure to maintain existing capital
• Crowding Out of Investment
• Government deficits & debt increasing long term interest rates!
• Increased income inequality  Populist policies
• Restrictions on Free International Trade

Misery Index: A combination of inflation and unemployment in any given year

• Single digit misery id good
• If double digit, considered miserable

Supply Shock: A rapid and significant increase in resource prices which causes SRAS curve to shift while producing a corresponding shift in the short-run fillips curve

Supply shock leads to stagflation

Stagflation: Where you have a simultaneous increase in inflation and unemployment

Disinflation: When inflation decreases

Real GDP and inflation are directly correlated



Supply-side Economics

• Tend to believe that the AS curve will determine levels of inflation, unemployment and economic growth
• Supports policies that promote GDP growth by arguing that high marginal tax rates along with the current system of transfer payments
• Ex. Unemployment, Social Security, and Welfare
• Provide disincentives to work, invest, innovate, and promote ventures. 

Marginal Tax Rates: The amount of tax made by an additional dollar income

• Changes from year to year

Laffer Curve

• As tax rates increase from 0, tax revenue increase from 0 to some maximum level and then they decline
• Direct correlation between tax rates (progressive) and government revenue
• Tax rates above or below the ideal rate will cause a decrease in tax revenue

3 Criticisms of Laffer Curve

1. Is where the economy is actually located on the Laffer curve is difficult to determine
2. Tax cuts also increase demand, which can fuel inflation therefore demand money may exceed supply
3. The impact of tax rates on incentives to work, sale, and invest are small