Chapter 8 The NewKeynesian Theory of Aggregate Supply

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Chapter 8 The New-Keynesian Theory of Aggregate Supply

Chapter 8 The New-Keynesian Theory of Aggregate Supply

Introduction • - Great Depression Classical Model The neutrality of money Vertical AS -

Introduction • - Great Depression Classical Model The neutrality of money Vertical AS - New-Keynesian Model - Sticky Price - Upward Slopped AS 2

The Classical and New-Keynesian Theories of Aggregate Supply Compared Figure 8. 1 A 3

The Classical and New-Keynesian Theories of Aggregate Supply Compared Figure 8. 1 A 3 © 2002 South-Western College Publishing

The Classical and New-Keynesian Theories of Aggregate Supply Compared Figure 8. 1 B 4

The Classical and New-Keynesian Theories of Aggregate Supply Compared Figure 8. 1 B 4 © 2002 South-Western College Publishing

The Theory of Nominal Rigidity • Two approaches: - The menu cost approach -

The Theory of Nominal Rigidity • Two approaches: - The menu cost approach - The contract theory of wages Rigid nominal wages (This Chapter) 5

The Theory of Sticky Wages • The new-Keynesian theory of AS begins with the

The Theory of Sticky Wages • The new-Keynesian theory of AS begins with the efficiency wage model and adds to it, assuming that the nominal wage is chosen less frequently than employment. • Employment contract The aggregate real wage may differ from the efficiency wage over long periods of time. 6

Unemployment and the Price Level when the Nominal Wage is Sticky 7

Unemployment and the Price Level when the Nominal Wage is Sticky 7

How Changes in the Price Level Affect Employment Figure 8. 2 A 8 ©

How Changes in the Price Level Affect Employment Figure 8. 2 A 8 © 2002 South-Western College Publishing

How Changes in the Price Level Affect Employment Figure 8. 2 B 9 ©

How Changes in the Price Level Affect Employment Figure 8. 2 B 9 © 2002 South-Western College Publishing

Aggregate Supply and the Price Level when the Nominal Wage is Sticky 10

Aggregate Supply and the Price Level when the Nominal Wage is Sticky 10

The New-Keynesian Theory of Aggregate Supply Figure 8. 3 11 © 2002 South-Western College

The New-Keynesian Theory of Aggregate Supply Figure 8. 3 11 © 2002 South-Western College Publishing

Okun’s Law • Okun’s Law says that when unemployment increases by 1 percentage point,

Okun’s Law • Okun’s Law says that when unemployment increases by 1 percentage point, GDP will fall 3% below trend. • See BOX 8. 2 12

From the Short Run to the Long Run 13

From the Short Run to the Long Run 13

Getting from the Short Run to the Long Run Figure 8. 4 14 ©

Getting from the Short Run to the Long Run Figure 8. 4 14 © 2002 South-Western College Publishing

The New-Keynesian Model and the Non-Neutrality of Money 15

The New-Keynesian Model and the Non-Neutrality of Money 15

The Non-Neutrality of Money in the Keynesian Model Figure 8. 5 16

The Non-Neutrality of Money in the Keynesian Model Figure 8. 5 16

Should We Stabilize the Business Cycle • The Real Business Cycle School - Most

Should We Stabilize the Business Cycle • The Real Business Cycle School - Most recessions are generated by fluctuations in the natural rate and that the mechanism that restores equilibrium is very fast. • Keynesians: - Some business cycles are not caused by changes in technology like the Great Depression. 17

Homework Question 4, 6, 7, 8 18

Homework Question 4, 6, 7, 8 18

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