Chapter 24

Chapter 24 - Chapter 24: From the Short Run to the Long Run...

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Factor Prices Variables Assumptions Regarding: The Short Run The Adjustment Process The Long Run Factors prices Exogenous Flexible (endogenous) Fully adjusted (endogenous) Technology and factor supplies (and Y*) Constant (exogenous) Constant (exogenous) Changing (endogenous) Implied Causes of Output Changes: AD/AS shocks cause Y to fluctuate around constant Y* Following AD or AS shocks, Y returns to Y* Changes in Y* determine changes in Y 24.1 The Adjustment Process Potential Output and the Output Gap Potential output is the total output that can be produced when all productive resources – land, labour, and capital – are being used at their normal rates of utilization. In this chapter, we view variations in the output gap as determined solely by variations in actual GDP around a constant level of potential GDP. Output gap is the difference between potential GDP and actual GDP: Y < Y*: Recessionary gap Y > Y*: Inflationary gap Factor Prices and the Output Gap Output Above Potential When real GDP is above potential output, demand for factors will be high and there will be pressure on factor prices to rise The boom that is associated with an inflationary gap generates a set of conditions – high profits for firms and unusually large demand for labour – that tends to cause wages (and other factor prices) to rise. o Increase firm’s unit costs AS curve will shift up (reduces equilibrium, rises price level) Output Below Potential The slump that is associated with a recessionary gap generates a set of conditions – low profits for firms and low demand for labour – that tends to cause wages (and other factors prices) to fall. When real GDP is below potential output, demand for factors will be low and there will be pressure on factor prices to fall. o Reduction of firm’s unit costs AS curve will shift down (increases equilibrium, reduces price level) Adjustment Asymmetry Both upward and downward adjustments to wages and unit costs do occur, but there are differences in the speed at which they typically operate. Booms can cause wages to rise rapidly AND recessions usually cause wages to fall only
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This note was uploaded on 04/17/2008 for the course ECON 295 taught by Professor Ragan during the Winter '08 term at McGill.

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Chapter 24 - Chapter 24: From the Short Run to the Long Run...

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