Chapter 30

Chapter 30 - Chapter 30 Adding inflation to the model Why...

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Chapter 30 Adding inflation to the model Why wages change Out-Gap Effect : o Response of wages to excess D or S of labor o Y>Y* excess D for labor wage rates rise o Y<Y* excess S of labor, wage rates fall o Y=Y* neither excess D nor excess S, no demand effect on wage rates. Expectational Effect o Response of wages to expectations of future inflation. – generate upward pressure on wage rates Change in money wages= Output Gap Effect + Expectational effect o How do people for their expectations? Forward looking people (change expectations rapidly as circumstances change about the future Backward-looking (basing their expectations of the future about what has happened in the past – change expectations slowly) Combination – sometimes looking backwards and forwards depends on different circumstances From wages to prices Increase in nominal wages increases costs of production, shifting the AS curve vertical up(to the left) and increasing P. o Output gaps put pressure on both wages and prices o Actual Inflation Rate = output-gap inflation + expected inflation + supply-shock inflation o The last term captures and shifts in the AS curve caused by things other than wage changes. E.g. productivity % increase productivity = % increase wage rates, AS not shift
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% increase productivity > % wage rates, AS shift down. % increase productivity < % increase wage rates, AS shift up o Another supply shock would be an increase in the price of raw materials. o Actual inflation = output-gapinflation + expected inflation o Actual inflation depends on relative strength of the 2 components o Y>Y* actual inflation>expected inflation o Y<Y* actual inflation < expected inflation o Y=Y* actual inflation = expected inflation Constant inflation At Y=Y* there is no output gap, so the ACTUAL INFLATION = EXPECTED
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Chapter 30 - Chapter 30 Adding inflation to the model Why...

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