ECON-205 Chapter 16 Notes

ECON-205 Chapter 16 Notes - Chapter 16 The Trade-Off...

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Chapter 16 The Trade-Off Between Inflation and Unemployment Terms Demand-side inflation is a rise in the price level caused by rapid growth of aggregate demand. Supply-side inflation is a rise in the price level caused by slow growth (or decline) of aggregate supply. A Phillips curve is a graph depicting the rate of unemployment on the horizontal axis and either the rate of inflation or the rate of change of money wages on the vertical axis. Phillips curves are normally downward slopping, indicating that higher inflation rates are associated with lower unemployment rates. The economy’s self-correcting mechanism always tends to push the unemployment rate back toward a specific rate of unemployment that we call the natural rate of unemployment . The vertical (long-run) Phillips curve shows the menu of inflation/unemployment choices available to society in the long run. It is a vertical straight line at the natural rate of unemployment. Rational expectations are forecasts that, while not necessarily correct, are the best that can be made given the available data. Rational expectations, therefore, cannot err systematically. If expectations are rational, forecasting errors are pure random numbers. Indexing refers to provisions in a law or a contract whereby monetary payments are automatically adjusted whenever a specialized price index changes. Wage rates, pensions, interest payments on bonds, income taxes, and many other things can be indexed in this way, and have been. Sometimes such contractual provisions are called escalator clauses.
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This note was uploaded on 04/30/2008 for the course ECON 205 taught by Professor Kamrany during the Fall '07 term at USC.

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ECON-205 Chapter 16 Notes - Chapter 16 The Trade-Off...

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