lnc15 - Lecture Notes Companion 15-Chapter 35 I. The modern...

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Lecture Notes Companion 15--Chapter 35 I. The modern (classical) Phillips Curve The Phillips Curve, which sums up much of the debate about macroeconomics, is not surprisingly the battleground between various schools of Classical and Keynesian economists, as well as others. The model we'll present here is, as in the text, the "standard" classical model, essentially a monetarist model. A. Assumptions The model assumes adaptive expectations (see text). (For rational expectations, the model is essentially the same, except that the adjustment process is much quicker, perhaps to the point where the short run effects vanish altogether.) Expectations play a key role in the model. Recall that the relationship between the actual inflation rate, i a , and the expected inflation rate, i e , can be used to determine the current condition of the economy: Why? If i a > i e , say 4% and 2% respectively, then labor contracts, for example, will include provisions for wage increases of 2% to make up for inflation. But if the rate of inflation actually turns out to be 4% during the contract period, then workers' real wages will be eroded by inflation. Firms will find that, in real terms, production costs fall, and hence profits rise. They will increase production and will hire more workers, thus engendering a boom. Of course, this will last only until new inflationary expectations result in new labor contracts with provisions for 4% wage increases. When the two rates are equal again, profits are at their "usual" level, and the economy moves back to equilibrium. Be very observant of the relationship of these two variables in the example which follows. 1.
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This note was uploaded on 11/23/2011 for the course ECON 231 taught by Professor Staff during the Fall '09 term at Calhoun Community College.

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lnc15 - Lecture Notes Companion 15-Chapter 35 I. The modern...

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