1 Diploma Macro Paper 2 Monetary Macroeconomics Lecture 6 Aggregate supply and putting AD and AS...

31
1 Diploma Macro Paper 2 Monetary Macroeconomics Lecture 6 Aggregate supply and putting AD and AS together Mark Hayes

Transcript of 1 Diploma Macro Paper 2 Monetary Macroeconomics Lecture 6 Aggregate supply and putting AD and AS...

Page 1: 1 Diploma Macro Paper 2 Monetary Macroeconomics Lecture 6 Aggregate supply and putting AD and AS together Mark Hayes.

1

Diploma Macro Paper 2

Monetary Macroeconomics

Lecture 6

Aggregate supply

and putting AD and AS together

Mark Hayes

Page 2: 1 Diploma Macro Paper 2 Monetary Macroeconomics Lecture 6 Aggregate supply and putting AD and AS together Mark Hayes.

Goods marketKX and IS

(Y, C, I)

Moneymarket (LM)

(i, Y)

IS-LM(i, Y, C, I)

AD

Labour market(P, Y)

ASAD-AS

(P, i, Y, C, I)

Phillips Curve(,u)

Foreign exchange market(NX, e)

AD*-AS(P, e, Y, C, NX)

Exogenous: M, G, T, i*, πe

IS*-LM*(e, Y, C, NX)

AD*

Page 3: 1 Diploma Macro Paper 2 Monetary Macroeconomics Lecture 6 Aggregate supply and putting AD and AS together Mark Hayes.

Goods marketKX and IS

(Y, C, I)

Moneymarket (LM)

(i, Y)

IS-LM(i, Y, C, I)

AD

Labour market(P, Y)

ASAD-AS

(P, i, Y, C, I)

Phillips Curve(,u)

Foreign exchange market(NX, e)

AD*-AS(P, e, Y, C, NX)

Exogenous: M, G, T, i*, πe

IS*-LM*(e, Y, C, NX)

AD*

Page 4: 1 Diploma Macro Paper 2 Monetary Macroeconomics Lecture 6 Aggregate supply and putting AD and AS together Mark Hayes.

4

Y1Y2

Deriving the AD* curve

Y

Y

P

IS*

LM*(P1)LM*(P2)

AD*

P1

P2

Y2 Y1

2

1

Why AD* curve has negative slope:

P

LM shifts left

NX

Y

(M/P)

Page 5: 1 Diploma Macro Paper 2 Monetary Macroeconomics Lecture 6 Aggregate supply and putting AD and AS together Mark Hayes.

5

Mundell-Fleming and the AD* curve

Previously P was fixed, now we are changing it.

NX is a function of , not e.

We now write the M-F equations as:

This means that the diagram does not show us the eq’m for e but we do not need this explicit for AD*

𝑰𝑺∗ :𝒀=𝒄𝟏(𝒀 −𝑻 )+𝑰 (𝒊∗)+𝑮+𝑵𝑿 ()

𝑳𝑴 ∗ :¿¿

Page 6: 1 Diploma Macro Paper 2 Monetary Macroeconomics Lecture 6 Aggregate supply and putting AD and AS together Mark Hayes.

6

The effect of an increase in demand in the ‘short run’ and the ‘long run’

Y

P

AD1

LRAS

Y

SRAS1

P2

Y2

A = initial (full employment) equilibrium

AB

CB = new short-run

eq’m after a boom in confidence

C = long-run equilibrium

AD2

SRAS2

P1

Page 7: 1 Diploma Macro Paper 2 Monetary Macroeconomics Lecture 6 Aggregate supply and putting AD and AS together Mark Hayes.

7

Keynes’s original AD-AS model

employment, N

D

expected

income

AS

AD

Equilibrium employment

D*

Effective demand

Page 8: 1 Diploma Macro Paper 2 Monetary Macroeconomics Lecture 6 Aggregate supply and putting AD and AS together Mark Hayes.

8

P

Y_

Y

LRAS

AD

SRAS

A post-Keynesian AD-AS model in P, Y space

Y

Page 9: 1 Diploma Macro Paper 2 Monetary Macroeconomics Lecture 6 Aggregate supply and putting AD and AS together Mark Hayes.

9

P

Y_

Y

LRASAD

SRAS

𝒀 −𝒀=𝜶 (𝑷−𝑷𝒆 )

Pe

Page 10: 1 Diploma Macro Paper 2 Monetary Macroeconomics Lecture 6 Aggregate supply and putting AD and AS together Mark Hayes.

10

Three models of aggregate supply

1. The imperfect-information model

2. The sticky-price model

3. The sticky-wage model

All three models imply:

( )eY Y P P

natural rate of output

a positive paramet

er

the expected price level

the actual price level

agg. outpu

t

Page 11: 1 Diploma Macro Paper 2 Monetary Macroeconomics Lecture 6 Aggregate supply and putting AD and AS together Mark Hayes.

11

Three models of aggregate supply

1. The imperfect-information model

2. The sticky-price model

3. The sticky-wage model

All three models imply:

a positive paramet

er

Deviations in price level

from expectation

Deviations in

output

𝒀 −𝒀=𝜶 (𝑷−𝑷𝒆 )

Page 12: 1 Diploma Macro Paper 2 Monetary Macroeconomics Lecture 6 Aggregate supply and putting AD and AS together Mark Hayes.

12

The imperfect-information model

Assumptions: All wages and prices are perfectly flexible,

all markets clear Each supplier produces one good, consumes

many goods. Supply of each good depends on its relative

price: the nominal price of the good divided by the overall price level.

Page 13: 1 Diploma Macro Paper 2 Monetary Macroeconomics Lecture 6 Aggregate supply and putting AD and AS together Mark Hayes.

13

The imperfect-information model

All suppliers know the nominal price of the good they produce, but do not know the general price level.

Supplier does not know general price level at the time of the production decision, so uses the expected price level, P e.

Suppose P rises but P e does not. Supplier thinks it is their own relative price which

has risen, so produces more. With many producers thinking this way,

Y will rise whenever P rises above P e.

Page 14: 1 Diploma Macro Paper 2 Monetary Macroeconomics Lecture 6 Aggregate supply and putting AD and AS together Mark Hayes.

14

The sticky-price model

Assumption: Firms set their own prices

(monopolistic competition).

Reasons for sticky prices: long-term contracts between firms and

customers menu costs firms not wishing to annoy customers with

frequent price changes

Page 15: 1 Diploma Macro Paper 2 Monetary Macroeconomics Lecture 6 Aggregate supply and putting AD and AS together Mark Hayes.

15

The sticky-price model

An individual firm’s desired price is

where a > 0.

Suppose two types of firms:• firms with flexible prices, set prices as

above• firms with sticky prices, must set their

price before they know how P and Y will turn out:

( )p P Y Y a

( )e e ep P Y Y a

Page 16: 1 Diploma Macro Paper 2 Monetary Macroeconomics Lecture 6 Aggregate supply and putting AD and AS together Mark Hayes.

16

The sticky-price model

Assume sticky price firms expect that output will equal its natural rate. Then,

( )e e ep P Y Y a

ep P

To derive the aggregate supply curve, we first find an expression for the overall price level.

Let s denote the fraction of firms with sticky prices. Then, we can write the overall price level as…

Page 17: 1 Diploma Macro Paper 2 Monetary Macroeconomics Lecture 6 Aggregate supply and putting AD and AS together Mark Hayes.

17

The sticky-price model

(1 )[ ( )]eP sP s P Y Y a

price set by flexible price

firms

price set by sticky price

firms

( ),eY Y P P where ( )

ss

1

a

(1 )( )e s

P P Y Ys

a

Page 18: 1 Diploma Macro Paper 2 Monetary Macroeconomics Lecture 6 Aggregate supply and putting AD and AS together Mark Hayes.

18

The sticky-wage model

Assumes that firms and workers negotiate contracts and fix the money wage before they know what the price level will turn out to be.

The money wage they set is the product of a target real wage and the expected price level:

eW ω P eW P

ωP P

Target real

wage

Page 19: 1 Diploma Macro Paper 2 Monetary Macroeconomics Lecture 6 Aggregate supply and putting AD and AS together Mark Hayes.

19

Page 20: 1 Diploma Macro Paper 2 Monetary Macroeconomics Lecture 6 Aggregate supply and putting AD and AS together Mark Hayes.

20

The sticky-wage model

If it turns out that

eW Pω

P P

eP P

eP P

eP P

then

Unemployment and output are at their natural rates.

Real wage is less than its target, so firms hire more workers and output rises above its natural rate.

Real wage exceeds its target, so firms hire fewer workers and output falls below its natural rate.

Page 21: 1 Diploma Macro Paper 2 Monetary Macroeconomics Lecture 6 Aggregate supply and putting AD and AS together Mark Hayes.

21

Chart 4.6 Real product wages, labour market slack and productivity

Sources: ONS (including the Labour Force Survey) and Bank calculations.

(a) Headline unemployment rate less the central Bank staff estimate of the medium-term equilibrium unemployment rate. For details, see the box on pages 28–29 of the August 2013 Report.(b) Private sector AWE total pay deflated by the market sector gross value added deflator.(c) Market sector output per worker.

Page 22: 1 Diploma Macro Paper 2 Monetary Macroeconomics Lecture 6 Aggregate supply and putting AD and AS together Mark Hayes.

22

Summary & implications

Each of the three models of agg. supply imply the relationship summarized by the SRAS curve & equation.

Each of the three models of agg. supply imply the relationship summarized by the SRAS curve & equation.

Y

P LRAS

Y

SRAS

( )eY Y P P

eP P

eP P

eP P

Page 23: 1 Diploma Macro Paper 2 Monetary Macroeconomics Lecture 6 Aggregate supply and putting AD and AS together Mark Hayes.

23

Summary & implications

Suppose a positive AD shock moves output above its natural rate and P above the level people had expected.

Y

P LRAS

SRAS1

SRAS equation: eY Y P P ( )

1 1eP P

AD1

AD22eP

2P3 3

eP P

Over time, P

e rises, SRAS shifts up,and output returns to its natural rate.

1Y Y 2Y3Y

SRAS2

Page 24: 1 Diploma Macro Paper 2 Monetary Macroeconomics Lecture 6 Aggregate supply and putting AD and AS together Mark Hayes.

24

Goods marketKX and IS

(Y, C, I)

Moneymarket (LM)

(i, Y)

IS-LM(i, Y, C, I)

AD

Labour market(P, Y)

ASAD-AS

(P, i, Y, C, I)

Phillips Curve(,u)

Foreign exchange market(NX, e)

AD*-AS(P, e, Y, C, NX)

Exogenous: M, G, T, i*, πe

IS*-LM*(e, Y, C, NX)

AD*

Page 25: 1 Diploma Macro Paper 2 Monetary Macroeconomics Lecture 6 Aggregate supply and putting AD and AS together Mark Hayes.

25

Inflation, Unemployment, and the Phillips CurveThe Phillips curve states that depends on expected inflation,

e.

cyclical unemployment: the deviation of the actual rate of unemployment from the natural rate

supply shocks, (Greek letter “nu”).

( ) e nu uwhere > 0 is an exogenous constant.

Page 26: 1 Diploma Macro Paper 2 Monetary Macroeconomics Lecture 6 Aggregate supply and putting AD and AS together Mark Hayes.

26

The Phillips Curve and SRAS

SRAS curve: Deviations in output are related to unexpected movements in the price level.

Phillips curve: Deviations in unemployment are related to unexpected movements in the inflation rate.

𝒀 −𝒀=𝜶 (𝑷−𝑷𝒆 )SRAS

Phillips curve 𝒖−𝒖𝒏=−𝟏 /𝜷 (𝝅 −𝝅𝒆−𝒗 )

Page 27: 1 Diploma Macro Paper 2 Monetary Macroeconomics Lecture 6 Aggregate supply and putting AD and AS together Mark Hayes.

27

Page 28: 1 Diploma Macro Paper 2 Monetary Macroeconomics Lecture 6 Aggregate supply and putting AD and AS together Mark Hayes.

28

Page 29: 1 Diploma Macro Paper 2 Monetary Macroeconomics Lecture 6 Aggregate supply and putting AD and AS together Mark Hayes.

29

Page 30: 1 Diploma Macro Paper 2 Monetary Macroeconomics Lecture 6 Aggregate supply and putting AD and AS together Mark Hayes.

30

Goods marketKX and IS

(Y, C, I)

Moneymarket (LM)

(i, Y)

IS-LM(i, Y, C, I)

AD

Labour market(P, Y)

ASAD-AS

(P, i, Y, C, I)

Phillips Curve(,u)

Foreign exchange market(NX, e)

AD*-AS(P, e, Y, C, NX)

Exogenous: M, G, T, i*, πe

IS*-LM*(e, Y, C, NX)

AD*

Page 31: 1 Diploma Macro Paper 2 Monetary Macroeconomics Lecture 6 Aggregate supply and putting AD and AS together Mark Hayes.

31

Next term

Policy effectiveness and inflation targeting

Origins of the North Atlantic and Euro crises