CH21 - 21 ADVANCEDTOPICS FOCUSOFTHECHAPTER Thischapter presents an overview offour recent ideas and models that have revolutionized modern

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21 A DVANCED  T OPICS FOCUS OF THE CHAPTER • This chapter  presents  an overview  of four recent ideas and  models that have revolutionized   modern  macroeconomics rational expectations  modeling, the random  walk theory  of GDP,  real business cycle theory, and  New  Keynesian  models of price stickiness.  Not all of these   ideas fit together some, in fact, contradict each other. • Much  of the technical material developed  in this chapter  is optional, or even super- optional you may  or may  not be required  to work  through  it.  Chapters  8 and  17 provide   very readable overviews  of the ideas developed  here.  If you  read  nothing  else, read  that. SECTION SUMMARIES 1. An Overview  of the New  Macroeconomics This section provides  an informal  introduction  to four subjects:  rational expectations  modeling,   the random  walk theory  of GDP, real business cycle theory, and  New  Keynesian  models of price   stickiness.  We discuss each briefly, noting  how  each is related  to the traditional aggregate   supply-aggregate  demand  model. The rational expectations  model outlined  in this chapter  (the Lucas model) tries to explain  how   output  can deviate from potential output  and  unemployment  from its natural  rate without   requiring  that prices adjust sluggishly.  We took a preliminary, non-technical look at this model in Chapter  6 (Section 6–3).  You may   recall some of the following:  In Lucas’s model, people cannot  directly observe the price level,   and  must  therefore form   expectations  of it.  When  these expectations  are wrong, people’s  estimates  of the real wage are also wrong, which causes them  to supply  “too much”  or “too   little” labor an amount  greater or less than  they would  choose to supply  if they knew  what   their real wage really was. The labor market  does clear in this model; the main  way  in which  the   226
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227 C HAPTER  21 aggregate supply  assumptions  differ from  the classical case of the AS-AD model is that the labor   supply, in this case, depends  on the expected  real wage rather  than  the actual real wage.  The assumption  that people’s expectations  are formed   rationally  (see The Language  of  Economics 6 for a review  of what  this means) creates an even greater difference between  this   model and  the standard  AS-AD model:  only unanticipated  AD shifts can affect output  and   unemployment  in the short run.  Instead  of a price level which  is slow to adjust to economic   shocks (as is the case with  the AS-AD model), we have here an expectation  of the price level  
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This note was uploaded on 12/02/2011 for the course ECON 209 taught by Professor Dr.martin during the Spring '09 term at Charleston.

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CH21 - 21 ADVANCEDTOPICS FOCUSOFTHECHAPTER Thischapter presents an overview offour recent ideas and models that have revolutionized modern

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