Shoe leather costs- cost of resources devoted to staying ahead of change in pricesMore Uncertainty- uncertainty about future costs/profitsHarms savers, lenders, fixed income and payees of fixed contracts2.Unanticipated Inflation- more serious, cases more troubleBenefits spenders, borrowers, people who own resources, payers of fixed price contracts=> unanticipated inflation redistributes wealth from wealthy to the poor, some inflation if good, minimum unanticipated inflationDeflation- prices are falling overtime, only unanticipated. Harms spenders, borrowers, owned resources, payers of fixed price contractsNominal Interest rate (i), stated interest rate; Real Interest rate (r) interest rate that includes the effect of inflation in the purchasing power of money; Inflation Rate (), % change in prices over time.Fisher Equation (approximation): or Chapter 8Classical ModelDominant before great depression, resurgence in 1980’s “Supply Side Economics” and “Regeanomics”, relies on microeconomics, self-adjusting economy, markets always clear, limited role of gov. Assumptions:1.Rational Self-Interest- firms maximize profits, households maximize utility2.Prices, wages, rents & interest rates are flexible so that markets always clear3.No money illusion- economic decisions are based on real variables, not nominal variables4.Law of Diminishing Returns- marginal products of input decline as it is added to other fixed inputsPieces of the Classical Model:1)Production Function- Y= Real GDP, K= Capital, L=Labor=> 2)Labor Market- w= real wage rate, P= price level, W=nominal wage rate/price level
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3)Product Market- Aggregate Supply (AS)= desired output, Aggregate Demand (AD)= desired spendingLabor MarketDeriving Labor Demand: firms maximize profits by hiring labor up to the point where W=MPL, MPL= Anytime the Production function changes, the demand for labor will also change and vice versa.Deriving Labor Supply: households face a tradeoff between income & leisure, opportunity cost of leisure is the real wage rate (w). As w↑, the opportunity cost of leisure↑=> households consume less leisure and supply more laborProduct ModelAggregate supply (AS) (desired output): the quantity of Real GDP that firms and workers are willing and able to produce at different price levels.Aggregate Demand (AD) (desired spending): the quantity of Real GDP that spenders in the economy are willing and able to purchase at different price levels*In the classical model prices adjust so that there is just enough spending in the economy to purchase the amount of output producedDeriving Aggregate Supply:
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