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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 shortrun tradeoff between inflation and unemployment known as the Phillips curve Chapter 13: Aggr egate Supply and the Shor tr 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: Stickyprice model Imperfectinformation 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 upwardsloping. 4 CHAPTER 13 Aggregate Supply The stickyprice model Reasons for sticky prices: longterm 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 stickyprice 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 stickyprice 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 stickyprice 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 stickyprice 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.
 Spring '10
 dee
 International Economics

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