Lec 4 AS and Phillips curve.pptx

Lec 4 AS and Phillips curve.pptx - AS and Phillips curve...

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Lecture 4 Mentor: Pham Xuan Truong ([email protected]) AS and Phillips curve
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Content I Four models of aggregate supply II Phillips curve
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Model Background Most economists analyze short-run fluctuations in aggregate income and the price level using the AD/AS model. Earlier we introduced long-run AS as a vertical line which implied perfect flexibility for prices. Our short-run AS curve was perfectly horizontal which implied perfect rigidity for prices. Now to better reflect the real world in which some prices are sticky and others are not. we will propose theories for a positively sloped AS curve. This implies a tradeoff between inflation and unemployment. All three models adhere to the following functional form of aggregate supply. where α >0, Y is output, is the natural rate of output, P is the price level, and P e is the expected price level. ( ) e Y Y P P Y
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Model Background This equation states that output deviates from its natural rate when the price level deviates from the expected price level. α indicates how much output responds to unexpected changes in P and 1/α is the slope of the AS curve. Although each of the three theories adheres to the given functional form, each highlights a different reason why unexpected movements in the price level are associated with fluctuations in aggregate output. ( ) e Y Y P P
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I Four models of aggregate supply (1) The sticky wage model (2) The worker - misperception model (3) The imperfect information model (4) The sticky price model (1) (2) Focus on labor market; (3) (4) Focus on goods market (1) (2) (3) From P change to Y change; (4) From Y change to P change (1) (4) price and wage are sticky; (2) (3)price and wage are flexible
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(1) The Sticky Wage Model Many economists believe that nominal wages are sticky in the short run. L 0 L W/P D L When the nominal wage is stuck, a rise in P from P 0 to P 1 lowers the real wage, making labour cheaper. W/P 0 W/P 1 L 1 The lower real wage induces firms to hire more labour. Th e additional la b our hired produces more output. The positive relationship between P and Y means AS slopes upward. L 0 L Y=F(L) Y 1 Y 0 L 1 Y Y 1 Y P 1 P 0 Y 0 P ( ) e Y Y P P
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The downfall of the sticky wage model is that it predicts a countercyclical relationship between the real wage and output. Actual data suggests a procyclical relationship, meaning that nominal wage is not rigid as the model predicts (1) The Sticky Wage Model
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