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Macro%20Chapter%2016B

Macro%20Chapter%2016B - Chapter 16 Short-Run Trade-off...

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1 Chapter 16 Short-Run Trade-off Between Inflation and Short-Run Trade-off Between Inflation and Unemployment Unemployment
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2 Main issues : How are inflation and unemployment related in the short run? In the long run? What factors alter this relationship? What is the short-run cost of reducing inflation?
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3 In the long run , inflation & unemployment are unrelated: The inflation rate depends mainly on growth in the money supply Unemployment (the “natural rate”) depends on the minimum wage, the market power of unions, efficiency wages, and the process of job search.
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4 In the short run , society faces a trade-off between inflation and unemployment. If policymakers expand aggregate demand, they can lower unemployment, but only at the cost of higher inflation. If they contract aggregate demand, they can lower inflation, but at the cost of temporarily higher unemployment.
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5 The Phillips Curve Phillips curve : shows the short-run combinations of unemployment and inflation that arise as shifts in the aggregate demand curve move the economy along the short-run aggregate supply curve. 1958: A.W. Phillips showed that nominal wage growth was negatively correlated with unemployment in the U.K. 1960: Paul Samuelson & Robert Solow found a negative correlation between U.S. inflation & unemployment - named it “the Phillips Curve.”
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6 Deriving the Phillips Curve Suppose P = 100 this year. The following graphs show two possible outcomes for next year: A . aggregate demand low, small increase in P ( i.e ., low inflation), low output, high unemployment. B . aggregate demand high, big increase in P ( i.e ., high inflation), high output, low unemployment.
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7 Deriving the Phillips Curve u-rate inflation PC A. Low aggregate demand, low inflation, high u-rate B. High aggregate demand, high inflation, low u-rate Y P SRAS AD 1 AD 2 Y 1 103 A 105 Y 2 B 6% 3% A 4% 5% B
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8 The Phillips Curve and Economic Policy Since fiscal & monetary policy affect aggregate demand,
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