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Ch13 - CHAPTER 1 3 U.S Inflation Unemployment and Business...

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U.S. Inflation, Unemployment, and Business Cycles CHAPTER 13
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2 After studying this chapter you will be able to Describe the patterns in output and inflation in the evolving U.S. economy Explain how demand-pull and cost-push forces bring cycles in inflation and output Explain the short-run and long-run tradeoff between inflation and unemployment Explain how the mainstream business cycle theory and real business cycle theory account for fluctuations in output and employment
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Inflation Plus Unemployment Equals Misery In the 1970s, when inflation was raging at a double-digit rate, Arthur M. Okun proposed a Misery Index—the inflation rate plus the unemployment rate. At its peak in 1981, the Misery Index reached 21. At its lowest in 1964 and again in 1999, the Misery Index was 6. We want low inflation and low unemployment. But can we have both together? Or do we face a tradeoff between these two macroeconomic policy goals?
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The Evolving U.S. Economy Figure 13.1 interprets the changes in real GDP and the price level each year from 1960 to 2005 in terms of shifting AD , SAS , and LAS curves. In 1960, the price level was 21 and real GDP was $2.5 trillion.
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The Evolving U.S. Economy By 2005, the price level was 112 and real GDP was $11.1 trillion. The dots show three features: Business cycles Inflation Economic growth
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The Evolving U.S. Economy Business Cycles Over the years, the economy grows and shrinks in cycles. The figure highlights the recessions since 1960.
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The Evolving U.S. Economy Inflation The upward movement of the dots shows inflation. Economic Growth The rightward movement of the dots shows the growth of real GDP.
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Inflation Cycles In the long run, inflation occurs if the quantity of money grows faster than potential GDP. In the short run, many factors can start an inflation, and real GDP and the price level interact. To study these interactions, we distinguish two sources of inflation: Demand-pull inflation Cost-push inflation
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Inflation Cycles Demand-Pull Inflation An inflation that starts because aggregate demand increases is called demand-pull inflation . Demand-pull inflation can begin with any factor that increases aggregate demand. Examples are a cut in the interest rate, an increase in the quantity of money, an increase in government expenditure, a tax cut, an increase in exports, or an increase in investment stimulated by an increase in expected future profits.
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Inflation Cycles Initial Effect of an Increase in Aggregate Demand Figure 13.2(a) illustrates the start of a demand- pull inflation. Starting from full employment, an increase in aggregate demand shifts the AD curve rightward.
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Inflation Cycles The price level rises, real GDP increases, and an inflationary gap arises. The rising price level is the first step in the demand-pull inflation.
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Inflation Cycles Money Wage Rate Response Figure 13.2(b) illustrates the money wage response.
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