CH 24 - From the Short-Run to the Long-Run

CH 24 - From the Short-Run to the Long-Run - CHAPTER 24...

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CHAPTER 24 FROM THE SHORT-RUN TO THE LONG-RUN 24.1 THE ADJUSTMENT PROCESS POTENTIAL OUTPUT + THE OUTPUT GAP: Potential output (Y*) is the level of real GDP at which all factors of production are being used at their normal rates of utilization The output gap is the difference between potential output + the actual level of real GDP, the latter determined by the intersection of the AD + AS curves FACTOR PRICES + THE OUTPUT GAP: Inflationary Gap (Y > Y*) = there is excess demand in factor markets o Wages + other factor prices rise causing firm’s unit cost to rise o AS Curve shifts upwards = price level rises ( Above Potential Output) o The boom associated with n inflationary gap generates a set of conditions [high profits for firms + unusually large demand for labor] that tend to cause wages to rise Recessionary Gap (Y < Y*) = there is excess supply in factor markets o Wages + other factor prices fall firm’s unit costs fall o AS Curve gradually shifts downward = eventually returning to potential output ( Below Potential Output) o The slump that is associated with a recessionary gap generates a set of conditions [low profits for firms + low demand for labor] that tend to cause wages + other factor prices to fall Adjustment Asymmetry: o Both upward + downward adjustments to wages + unit costs do occur, but there are differences in the speed at which they typically operate. Booms = cause wages to rise rapidly Recession = cause wages to fall slowly Phillips Curve: o Observes that wages tend to fall in periods of high unemployment and rise in periods of low unemployment o Phillips Curve = negative relationship between unemployment + rate of change in wages o Originally a relationship between the unemployment rate + the rate of change of money wages. Now often drawn as a relationship between GDP + the rate of change in money wages POTENTIAL OUTPUT AS AN “ANCHOR” In our macro model, the level of potential output (Y*) acts as an “anchor” for the economy. Given the short-run equilibrium as determined by the AD + AS curves, wages + other factor prices will adjust = shifting the AS curve up, until output returns to Y* Following an AD or AS shock, the short-run equilibrium level of output may be different
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CH 24 - From the Short-Run to the Long-Run - CHAPTER 24...

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