ch14b - 1 CHAPTER 14 Dynamic AD-AS Model The models...

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Unformatted text preview: 1 CHAPTER 14 Dynamic AD-AS Model The models long-run equilibrium The normal state around which the economy fluctuates. Two conditions required for long-run equilibrium: There are no shocks: Inflation is constant: t t = = 1 t t - = 2 CHAPTER 14 Dynamic AD-AS Model The models long-run equilibrium Plugging the preceding conditions into the models five equations and using algebra yields these long-run values: t t Y Y = t r = * t t = * 1 t t t E + = * t t i = + 3 CHAPTER 14 Dynamic AD-AS Model The Dynamic Aggregate Supply Curve The DAS curve shows a relation between output and inflation that comes from the Phillips Curve and Adaptive Expectations: 1 ( )- = +- + t t t t t Y Y ( DAS ) 4 CHAPTER 14 Dynamic AD-AS Model The Dynamic Aggregate Supply Curve DAS slopes upward: high levels of output are associated with high inflation. Y DA S t 1 ( )- = +- + t t t t t Y Y DAS shifts in response to changes in the natural level of output, previous inflation, and supply shocks. 5 CHAPTER 14 Dynamic AD-AS Model The Dynamic Aggregate Demand Curve To derive the DAD curve, we will combine four equations and then eliminate all the endogenous variables other than output and inflation. Start with the demand for goods and services: ( ) t t t t Y Y r =-- + 1 ( ) + =--- + t t t t t t Y Y i E using the Fisher eqn 6 CHAPTER 14 Dynamic AD-AS Model The Dynamic Aggregate Demand Curve 1 ( ) + =--- + t t t t t t Y Y i E result from previous slide ( ) =--- + t t t t t Y Y i using the expectations eqn * [ ( ) ( ) ] =- + +- +--- + t t t t t Y t t t t Y Y Y Y using monetary policy rule * [ ( ) ( )] =-- +- + t t t t Y t t t Y Y Y Y 7 CHAPTER 14 Dynamic AD-AS Model The Dynamic Aggregate Demand Curve result from previous slide combine like terms, solve for Y * [ ( ) ( )] =-- +- + t t t t Y t t t Y Y Y Y 1 A 0, B 1 1 = = + + Y Y * A( ) B , =-- + t t t t t Y Y where ( DAD ) 8 CHAPTER 14 Dynamic AD-AS Model The Dynamic Aggregate Demand Curve DAD slopes downward: When inflation rises, the central bank raises the real interest rate, reducing the demand for goods & services. Y DAD shifts in response to changes in the natural level of output, the inflation target, and demand shocks. DA D t * A( ) B =-- + t t t t t Y Y 9 CHAPTER 14 Dynamic AD-AS Model Y t The short-run equilibrium In each period, the intersection of DAD and DAS determines the short-run eqm values of inflation and output. t Yt Y DA D t DA S t A In the eqm shown here at A , output is below its natural level. 10 CHAPTER 14 Dynamic AD-AS Model Long-run growth Period t : initial eqm at A Y DA S t Yt DAD t A Yt t Period t + 1 : Long-run growth increases the natural rate of output....
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This note was uploaded on 05/08/2011 for the course ECON 362 taught by Professor Birz during the Fall '08 term at Binghamton University.

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ch14b - 1 CHAPTER 14 Dynamic AD-AS Model The models...

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