Diploma Macro Paper 2
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Transcript of Diploma Macro Paper 2
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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*
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*
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Y1Y2
Deriving the AD* curve
Y
Y
P
IS*
LM*(P1)LM*(P2)
AD*
P1
P2
Y2 Y1
2
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Why AD* curve has negative slope:
P
LM shifts left
NX
Y
(M/P)
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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 ∗ :¿¿
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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
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Keynes’s original AD-AS model
employment, N
D
expected
income
AS
AD
Equilibrium employment
D*
Effective demand
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P
Y_
Y
LRAS
AD
SRAS
A post-Keynesian AD-AS model in P, Y space
Y
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P
Y_
Y
LRASAD
SRAS
𝒀 −𝒀=𝜶 (𝑷−𝑷𝒆 )
Pe
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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
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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 )
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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.
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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.
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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
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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
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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…
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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
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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
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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.
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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.
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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
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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
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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*
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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.
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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 )
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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*
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Next term
Policy effectiveness and inflation targeting
Origins of the North Atlantic and Euro crises