Instructor17Commentary - 1 INSTRUCTOR COMMENTARY Lecture...

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INSTRUCTOR COMMENTARY Lecture Reference: Lecture 15 Chapter Reference: Chapter 17 and the Appendix to Chapter 10 The Phillips Curve, Expectations Theory, and Macroeconomic Policy in the Short- and Long-run Lecture 15 (and Chapter 17 and the Appendix to Chapter 10) focus on the following important topics: A. The short-run Phillips Curve. The short-run Phillips curve shows the actual trade-offs between the unemployment rate and the rate of inflation for a given economy over a period of time. The curve is generally downward sloping, indicating that higher unemployment rates are associated with lower inflation rates. (pp. 410-412) B. The relationship between the Phillips Curve and the AD-AS schedules in the short-run. Economists believe that the movements along a short-run Phillips curve are caused by movements along a short-run aggregate supply schedule induced by a change in aggregate demand. Beginning from a point of long-run equilibrium, an increase in aggregate demand causes firms to increase production levels as the prices of goods and services initially rise more quickly than production costs. The opportunities for increased profits exist and firms respond by increasing production and employment, so that the unemployment rate falls below its “natural” rate. The increased output and employment continue in the short-run so long as production costs do not rise proportionately with the increase in product prices, so that opportunities for additional profit remain. (pp. 410-411). C. Macroeconomic policy choices in the short-run. Macroeconomic policy choices in the short-run are based on the benefits and costs of unemployment and inflation. Knowing that a 1
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reduced unemployment rate comes at the cost of a higher inflation rate, policy makers must choose and move towards the “best” point on the short-run Phillips curve. (pp. 412-413) D. The long-run Phillips curve. The long-run Phillips Curve is vertical, depicting the reality that in the long-run there is no trade-off between inflation and unemployment. Beginning from a point of long-run equilibrium, an increase in aggregate demand may induce firms to expand production and employment (and reduce the unemployment rate) so long as it is profitable to do so. When all costs have an opportunity to adjust to the higher prices caused by the increase in aggregate demand, the profit opportunities associated with increased production disappear. As a result, the economy returns to its initial level of real GDP and employment, at the unemployment rate designated as the “natural” rate of unemployment. (text, pp. 413-414) E. The relationship between the Phillips Curve and the AD-AS schedules in the long-run. The long-run Phillips Curve is vertical because the long-run aggregate supply schedule is vertical. The long-run equilibrium level of GDP is that defined by the natural rate of unemployment.
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