ShortRun and Long Run Aggregate Supply ShortRun Aggregate

Short-Run and Long. Run Aggregate Supply Short-Run Aggregate Supply Long-Run Aggregate Supply Equilibrium with the Extended AD-AS Model 16 CHAPTER Demand-Pull Inflation Cost-Push Inflation The Phillips Curve Taxation and Aggregate Supply The Laffer Curve Key Terms Previous Slide End Show 16 - 1 Next Slide Extending the Analysis of Aggregate Supply Copyright Mc. Graw-Hill/Irwin, 2002

Short-Run and Long. Run Aggregate Supply Short-Run Aggregate Supply Long-Run Aggregate Supply Equilibrium with the Extended AD-AS Model Demand-Pull Inflation Cost-Push Inflation The Phillips Curve Taxation and Aggregate Supply The Laffer Curve Key Terms Previous Slide End Show 16 - 2 Next Slide SHORT-RUN AND LONG-RUN AGGREGATE SUPPLY Short Run - Period in which nominal wages (and other input prices) remain fixed as the price level increases or decreases Long Run Period in which nominal wages are fully responsive to previous changes in the price level Copyright Mc. Graw-Hill/Irwin, 2002

SHORT-RUN AGGREGATE SUPPLY Short-Run and Long. Run Aggregate Supply A higher price level increases profits and output moving the economy from a 1 to a 2 Short-Run Aggregate Supply AS 1 Long-Run Aggregate Supply Demand-Pull Inflation Cost-Push Inflation The Phillips Curve Taxation and Aggregate Supply Price Level Equilibrium with the Extended AD-AS Model P 2 P 1 a 2 a 1 The Laffer Curve Key Terms Previous Slide End Show 16 - 3 Next Slide o Copyright Mc. Graw-Hill/Irwin, 2002 Q 1 Q 2 Real domestic output

SHORT-RUN AGGREGATE SUPPLY Short-Run and Long. Run Aggregate Supply A lower price level decreases profits and output moving the economy from a 1 to a 3 Short-Run Aggregate Supply AS 1 Long-Run Aggregate Supply Demand-Pull Inflation Cost-Push Inflation The Phillips Curve Taxation and Aggregate Supply The Laffer Curve Key Terms Previous Slide End Show 16 - 4 Next Slide Price Level Equilibrium with the Extended AD-AS Model P 2 a 2 P 1 P 3 o Copyright Mc. Graw-Hill/Irwin, 2002 a 1 a 3 Q 1 Q 2 Real domestic output

LONG RUN AGGREGATE SUPPLY Short-Run and Long. Run Aggregate Supply Short-Run Aggregate Supply A higher price level results in higher nominal wages and thus shifts the short-run aggregate supply to the left ASLR AS 2 Long-Run Aggregate Supply Demand-Pull Inflation Cost-Push Inflation The Phillips Curve Taxation and Aggregate Supply Price Level Equilibrium with the Extended AD-AS Model P 2 P 1 b 1 AS 1 a 2 a 1 The Laffer Curve Key Terms Previous Slide End Show 16 - 5 Next Slide o Copyright Mc. Graw-Hill/Irwin, 2002 Q 1 Q 2 Real domestic output

LONG RUN AGGREGATE SUPPLY Short-Run and Long. Run Aggregate Supply Short-Run Aggregate Supply A lower price level results reduces nominal wages and shifts the short-run aggregate supply to the right ASLR AS 2 Long-Run Aggregate Supply Demand-Pull Inflation Cost-Push Inflation The Phillips Curve Taxation and Aggregate Supply The Laffer Curve Key Terms Previous Slide End Show 16 - 6 Next Slide P 2 Price Level Equilibrium with the Extended AD-AS Model b 1 AS 1 a 2 AS 3 a 1 P 3 o Copyright Mc. Graw-Hill/Irwin, 2002 a 3 Q 3 c 1 Q 2 Real domestic output

Short-Run and Long. Run Aggregate Supply EQUILIBRIUM IN THE EXTENDED AD-AS MODEL ASLR Short-Run Aggregate Supply AS 1 Equilibrium with the Extended AD-AS Model Demand-Pull Inflation Cost-Push Inflation The Phillips Curve Taxation and Aggregate Supply The Laffer Curve Price Level Long-Run Aggregate Supply a P 1 Key Terms Previous Slide End Show 16 - 7 Next Slide AD 1 o Copyright Mc. Graw-Hill/Irwin, 2002 Q 1 Real domestic output

DEMAND-PULL INFLATION Short-Run and Long. Run Aggregate Supply ASLR Short-Run Aggregate Supply AS 2 AS 1 Equilibrium with the Extended AD-AS Model Demand-Pull Inflation Cost-Push Inflation The Phillips Curve Taxation and Aggregate Supply The Laffer Curve Price Level Long-Run Aggregate Supply c P 3 b P 2 a P 1 Key Terms Previous Slide End Show 16 - 8 AD 2 Next Slide AD 1 o Copyright Mc. Graw-Hill/Irwin, 2002 Q 1 Real domestic output

COST-PUSH INFLATION Occurs when short-run AS shifts left Short-Run and Long. Run Aggregate Supply ASLR Short-Run Aggregate Supply AS 1 Demand-Pull Inflation Cost-Push Inflation The Phillips Curve Taxation and Aggregate Supply The Laffer Curve Price Level Long-Run Aggregate Supply Equilibrium with the Extended AD-AS Model AS 2 b P 2 a P 1 Key Terms Previous Slide End Show 16 - 9 Next Slide AD 1 o Copyright Mc. Graw-Hill/Irwin, 2002 Q 1 Real domestic output

COST-PUSH INFLATION Government response with increased AD Short-Run and Long. Run Aggregate Supply ASLR Short-Run Aggregate Supply AS 1 Demand-Pull Inflation Cost-Push Inflation The Phillips Curve Taxation and Aggregate Supply The Laffer Curve Price Level Long-Run Aggregate Supply Equilibrium with the Extended AD-AS Model AS 2 c P 3 b P 2 a P 1 Even higher price levels Key Terms Previous Slide End Show 16 - 10 AD 2 Next Slide AD 1 o Copyright Mc. Graw-Hill/Irwin, 2002 Q 1 Real domestic output

COST-PUSH INFLATION If government allows a recession to occur Short-Run and Long. Run Aggregate Supply ASLR Short-Run Aggregate Supply AS 1 Demand-Pull Inflation Cost-Push Inflation The Phillips Curve Taxation and Aggregate Supply The Laffer Curve Price Level Long-Run Aggregate Supply Equilibrium with the Extended AD-AS Model AS 2 b P 2 a P 1 Key Terms Previous Slide End Show 16 - 11 Next Slide AD 1 o Copyright Mc. Graw-Hill/Irwin, 2002 Q 1 Real domestic output

COST-PUSH INFLATION If government allows a recession to occur Short-Run and Long. Run Aggregate Supply ASLR Short-Run Aggregate Supply AS 1 Demand-Pull Inflation Cost-Push Inflation The Phillips Curve Taxation and Aggregate Supply The Laffer Curve Price Level Long-Run Aggregate Supply Equilibrium with the Extended AD-AS Model b P 2 a P 1 Key Terms Previous Slide End Show 16 - 12 Next Slide AS 2 Nominal wages fall & AS returns to its original location AD 1 o Copyright Mc. Graw-Hill/Irwin, 2002 Q 1 Real domestic output

Short-Run and Long. Run Aggregate Supply Short-Run Aggregate Supply Long-Run Aggregate Supply Equilibrium with the Extended AD-AS Model Demand-Pull Inflation Cost-Push Inflation The Phillips Curve Taxation and Aggregate Supply The Laffer Curve Key Terms Previous Slide End Show 16 - 13 Next Slide THE INFLATION-UNEMPLOYMENT RELATIONSHIP • Normally, there is a short-run trade-off between the rate of inflation and the rate of unemployment • Aggregate supply shocks can cause both higher rates of inflation and higher rates of unemployment • There is no significant trade-off over long periods of time Copyright Mc. Graw-Hill/Irwin, 2002

Short-Run and Long. Run Aggregate Supply EFFECT OF CHANGES IN AGGREGATE DEMAND ON REAL OUTPUT AND THE PRICE LEVEL AD 0 AS Long-Run Aggregate Supply Equilibrium with the Extended AD-AS Model Demand-Pull Inflation Cost-Push Inflation The Phillips Curve Taxation and Aggregate Supply The Laffer Curve Key Terms Previous Slide End Show 16 - 14 Next Slide Price Level Short-Run Aggregate Supply P 0 o Q 0 Real domestic output Copyright Mc. Graw-Hill/Irwin, 2002

Short-Run and Long. Run Aggregate Supply EFFECT OF CHANGES IN AGGREGATE DEMAND ON REAL OUTPUT AND THE PRICE LEVEL AD 0 AD 1 AS Long-Run Aggregate Supply Equilibrium with the Extended AD-AS Model Demand-Pull Inflation Cost-Push Inflation The Phillips Curve Taxation and Aggregate Supply The Laffer Curve Key Terms Previous Slide End Show 16 - 15 Next Slide Price Level Short-Run Aggregate Supply P 1 P 0 o Q 0 Q 1 Real domestic output Copyright Mc. Graw-Hill/Irwin, 2002

Short-Run and Long. Run Aggregate Supply EFFECT OF CHANGES IN AGGREGATE DEMAND ON REAL OUTPUT AND THE PRICE LEVEL AD 0 AD 1 AD 2 AS Long-Run Aggregate Supply Equilibrium with the Extended AD-AS Model Demand-Pull Inflation Cost-Push Inflation The Phillips Curve Taxation and Aggregate Supply The Laffer Curve Key Terms Previous Slide End Show 16 - 16 Next Slide Price Level Short-Run Aggregate Supply P 2 P 1 P 0 o Q 0 Q 1 Q 2 Real domestic output Copyright Mc. Graw-Hill/Irwin, 2002

Short-Run and Long. Run Aggregate Supply EFFECT OF CHANGES IN AGGREGATE DEMAND ON REAL OUTPUT AND THE PRICE LEVEL AD 0 AD 1 AD 2 AD 3 AS Long-Run Aggregate Supply Equilibrium with the Extended AD-AS Model Demand-Pull Inflation Cost-Push Inflation The Phillips Curve Taxation and Aggregate Supply The Laffer Curve Key Terms Previous Slide End Show 16 - 17 Next Slide Price Level Short-Run Aggregate Supply P 3 P 2 P 1 P 0 o Q 0 Q 1 Q 2 Q 3 Real domestic output Copyright Mc. Graw-Hill/Irwin, 2002

THE PHILLIPS CURVE CONCEPT Short-Run and Long. Run Aggregate Supply Long-Run Aggregate Supply Equilibrium with the Extended AD-AS Model Demand-Pull Inflation Cost-Push Inflation The Phillips Curve Taxation and Aggregate Supply The Laffer Curve Annual rate of inflation (percent) Short-Run Aggregate Supply 7 As inflation declines. . . 6 5 Unemployment increases 4 3 2 Key Terms 1 Previous Slide End Show 16 - 18 Next Slide 0 1 2 3 4 5 6 7 Unemployment rate (percent) Copyright Mc. Graw-Hill/Irwin, 2002

GLOBAL PERSPECTIVE Short-Run and Long. Run Aggregate Supply The Misery Index, Selected Nations Italy 1990 - 2000 U. K. Short-Run Aggregate Supply Long-Run Aggregate Supply 15 Canada France Equilibrium with the Extended AD-AS Model Demand-Pull Inflation Cost-Push Inflation U. S. Germany 10 The Phillips Curve Taxation and Aggregate Supply The Laffer Curve Key Terms Previous Slide End Show 16 - 19 Next Slide Japan 5 0 1990 Copyright Mc. Graw-Hill/Irwin, 2002 1995 2000 Source: Bureau of Labor Statistics

THE LONG-RUN PHILLIPS CURVE Short-Run and Long. Run Aggregate Supply Short-Run Aggregate Supply Long-Run Aggregate Supply Equilibrium with the Extended AD-AS Model Demand-Pull Inflation Cost-Push Inflation Stagflation’s Demise Aggregate-Supply Shocks Short-Run Phillips Curve The Phillips Curve Taxation and Aggregate Supply The Laffer Curve Key Terms Previous Slide End Show 16 - 20 Next Slide Long-Run Vertical Phillips Curve Disinflation Copyright Mc. Graw-Hill/Irwin, 2002

TAXATION AND AGGREGATE SUPPLY Short-Run and Long. Run Aggregate Supply Short-Run Aggregate Supply Long-Run Aggregate Supply Equilibrium with the Extended AD-AS Model Demand-Pull Inflation Cost-Push Inflation The Phillips Curve Taxation and Aggregate Supply Taxes and Incentives to Work Incentives to Save and Invest The Laffer Curve Supply-Side Economics Key Terms Previous Slide End Show 16 - 21 Next Slide Laffer Curve Copyright Mc. Graw-Hill/Irwin, 2002

THE LAFFER CURVE 100 Short-Run Aggregate Supply Long-Run Aggregate Supply Equilibrium with the Extended AD-AS Model Demand-Pull Inflation Cost-Push Inflation The Phillips Curve Taxation and Aggregate Supply Tax rate (percent) Short-Run and Long. Run Aggregate Supply The Laffer Curve Key Terms l Previous Slide End Show 16 - 22 Next Slide 0 Tax revenue (dollars) Copyright Mc. Graw-Hill/Irwin, 2002

THE LAFFER CURVE 100 Short-Run Aggregate Supply Long-Run Aggregate Supply Equilibrium with the Extended AD-AS Model Demand-Pull Inflation Cost-Push Inflation The Phillips Curve Taxation and Aggregate Supply Tax rate (percent) Short-Run and Long. Run Aggregate Supply m The Laffer Curve Key Terms l Previous Slide End Show 16 - 23 Next Slide 0 Tax revenue (dollars) Copyright Mc. Graw-Hill/Irwin, 2002

THE LAFFER CURVE 100 Short-Run Aggregate Supply Long-Run Aggregate Supply Equilibrium with the Extended AD-AS Model Demand-Pull Inflation Cost-Push Inflation The Phillips Curve Taxation and Aggregate Supply n Tax rate (percent) Short-Run and Long. Run Aggregate Supply m The Laffer Curve Key Terms l Previous Slide End Show 16 - 24 Next Slide 0 Tax revenue (dollars) Copyright Mc. Graw-Hill/Irwin, 2002

THE LAFFER CURVE 100 Short-Run Aggregate Supply Long-Run Aggregate Supply Equilibrium with the Extended AD-AS Model Demand-Pull Inflation Cost-Push Inflation The Phillips Curve Taxation and Aggregate Supply Tax rate (percent) Short-Run and Long. Run Aggregate Supply n m m Maximum Tax Revenue The Laffer Curve Key Terms l Previous Slide End Show 16 - 25 Next Slide 0 Tax revenue (dollars) Copyright Mc. Graw-Hill/Irwin, 2002

Criticisms of the Laffer Curve Short-Run and Long. Run Aggregate Supply Short-Run Aggregate Supply Long-Run Aggregate Supply Equilibrium with the Extended AD-AS Model Demand-Pull Inflation Cost-Push Inflation The Phillips Curve Taxes, Incentives, and Time Inflation Position on the Curve Taxation and Aggregate Supply The Laffer Curve Chapter Conclusions Key Terms Previous Slide End Show 16 - 26 Next Slide Copyright Mc. Graw-Hill/Irwin, 2002

short run long run short-run aggregate supply curve long-run aggregate supply curve Phillips Curve stagflation aggregate supply shocks long-run vertical Phillips curve disinflation supply-side economics Laffer Curve Copyright Mc. Graw-Hill/Irwin, 2002 BACK END

Short-Run and Long. Run Aggregate Supply Short-Run Aggregate Supply Up next. . . Long-Run Aggregate Supply Equilibrium with the Extended AD-AS Model Demand-Pull Inflation Cost-Push Inflation The Phillips Curve Taxation and Aggregate Supply Economic Growth and the New Economy The Laffer Curve Key Terms Previous Slide End Show 16 - 28 Chapter 17 Next Slide Copyright Mc. Graw-Hill/Irwin, 2002