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ch%2013 - MACROECONOMICS CHAPTE R 13 Aggre gate S upply and...

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1 CHAPTER 13 Aggregate Supply MACROECONOMICS C H A P T E R Aggregate Supply and the Short-run Tradeoff Between Inflation and Unemployment 13
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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
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3 CHAPTER 13 Aggregate Supply Introduction § Both models imply: 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. ( ) Y Y P EP α = + -
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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 ( e.g. , as in monopolistic competition).
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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 = + - ( )
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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
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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
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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.
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