mankiw7e-chap13 - In this chapter you will learn two models...

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Unformatted text preview: In this chapter, you will learn: two models of aggregate supply in which output depends positively on the price level in the short run about the short-run tradeoff between inflation and unemployment known as the Phillips curve Chapter 13: Aggr egate Supply and the Shor t-r un Tr adeoff Between I nflation and Unemployment 2 CHAPTER 13 Aggregate Supply Introduction In previous chapters, we assumed the price level P was “stuck” in the short run. This implies a horizontal SRAS curve. Now, we consider two prominent models of aggregate supply in the short run: Sticky-price model Imperfect-information model 3 CHAPTER 13 Aggregate Supply Introduction Both models imply: ( ) Y Y P EP α = +- natural rate of output a positive parameter expected price level actual price level agg. output Other things equal, Y and P are positively related, so the SRAS curve is upward-sloping. 4 CHAPTER 13 Aggregate Supply The sticky-price model Reasons for sticky prices: long-term contracts between firms and customers menu costs firms not wishing to annoy customers with frequent price changes Assumption: Firms set their own prices (i.e. firms have some market power). 5 CHAPTER 13 Aggregate Supply The sticky-price model An individual firm’s desired price is: where a > 0. Suppose two types of firms: • firms with flexible prices, set prices as above • firms with sticky prices, must set their price before they know how P and Y will turn out: p P a Y Y = +- ( ) p EP a EY EY = +- ( ) 6 CHAPTER 13 Aggregate Supply The sticky-price model Assume sticky price firms expect that output will equal its natural rate. Then, To derive the aggregate supply curve, first find an expression for the overall price level. s = fraction of firms with sticky prices. Then, we can write the overall price level as… p EP a EY EY = +- ( ) = p EP 7 CHAPTER 13 Aggregate Supply The sticky-price model Subtract (1- s ) P from both sides: price set by flexible price firms price set by sticky price firms Divide both sides by s : 1 = +- +- [ ] ( )[ ( )] P s EP s P a Y Y 1 = +-- [ ] ( )[ ( )] sP s EP s a Y Y 1- = +- ( ) ( ) s a P EP Y Y s 8 CHAPTER 13 Aggregate Supply The sticky-price model High EP ⇒ High P If firms expect high prices, then firms that must set prices in advance will set them high. Other firms respond by setting high prices. High Y ⇒ High P When income is high, the demand for goods is high. Firms with flexible prices set high prices....
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This note was uploaded on 06/12/2011 for the course ECON 101 taught by Professor Dee during the Spring '10 term at Andhra University.

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mankiw7e-chap13 - In this chapter you will learn two models...

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