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Lecture 15

# Lecture 15 - ECONOMICS 100B Professor Steven Wood Lecture...

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ECONOMICS 100B Professor Steven Wood 03/08/11 Lecture 15 ASUC Lecture Notes Online is the only authorized note-taking service at UC Berkeley. Do not share, copy, or illegally distribute (electronically or otherwise) these notes. Our student-run program depends on your individual subscription for its continued existence. These notes are copyrighted by the University of California and are for your personal use only. D O N O T C O P Y Sharing or copying these notes is illegal and could end note taking for this course. LECTURE: Today’s lecture will focus on Chapter 10: The Phillips Curve and Aggregate Supply. CORRECTION TO LECTURE 14: The MP Curve does not need to be steeper than 45 degrees for the real interest rate. It is only steeper than 45 degrees for the nominal interest rate. ICLICKER QUESTIONS/ANSWERS: 1.) Friedman and Phelps argued that the original Phillips Curve analysis suffered from: implicitly assuming that firms and workers respond to nominal wages. 2.) As wages and prices become more flexible: inflation becomes more responsive to the output gap. 3.) In the long run, the economy reaches the output level that is consistent with the natural rate of unemployment. PHILLIPS CURVE: The Phillips curve is the inverse relationship between the inflation rate and the unemployment rate . When unemployment is low, the demand for labor is high relative to the supply of labor. This causes wages to rise more quickly. Since wages are a major input of total costs, rising wages leads to higher inflation. The Phillips curve is given by: π = - ωU , where 1. π = inflation 2. U = the unemployment rate 3. ω = the sensitivity of to changes in U. The following graph of the Phillips Curve shows that there is a trade-off between unemployment and inflation. The original Phillips curve also implied an inverse relationship between nominal wages and unemployment. Since wages are such a large part of total cost, the movement of wages and inflation is largely the same. However, a major flaw in the original Phillips curve analysis was that it did not distinguish between nominal and real wages. Workers and businesses respond to changes in real, not nominal, wages. So, if workers and businesses expect inflation to increase, they will raise nominal wages higher in order to ensure that the real wage does not fall.

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