10 Introduction Into the Short Run Flashcards
What do the short-run and long-run models deal with?
Long-run model → potential output, long-run inflation.
Short-run model → current output, current inflation.
What is one important assumption underlying the short-run model?
Potential output and long-run rate of inflation is given by the long-run model, outside of the short-run model.
Equation for short-run output gap
Diagram for Economic Fluctuations and Short-Run Output
What is evident from these two diagrams?
Similar shape, expect panel (b) does not include the long-run trend (as in the short-run we assume it is constant).
What are the simplest ways of measuring (approximating) potential GDP?
By assuming theres a perfectly smooth trend passing through quarter-to-quarter movements in real GDP.
Or,
Take averages of the surrounding actual GDP numbers.
What is an annualised rate?
The rate of change that would apply if the growth persisted for an entire year.
How does inflation rate change during recessions?
It typically falls.
What three premises is the short-run model based on?
- The economy is constantly being hit by shocks.
- Monetary and fiscal policy affect output.
- There is a dynamic trade-off between output and inflation.
What do “economic shocks” include?
What do they affect?
Economic shocks include: changes in oil prices, disruption in financial markets, new technology, military spending, and natural disasters.
Shocks can push actual output away from the potential and/or move the inflation rate away from its long-run value.
What is the “dynamic trade-off between output and inflation”?
Trade-off known as the Phillips curve. A booming economy (where actual output exceeds potential) creates inflationary pressure, raising the inflation rate. If it is too high, a recession is required to pull it back down.
What is the Phillips Cuve graph?
What is the economic intuition behind the Phillips curve during booms?
In booms:
production increases above potential (think of excess demand)
leading to higher labour costs as workers are paid more for overtime (already increasing prices).
Furthermore, despite extra production, it may not always meet demand, so the excess demand raises prices too, leading to higher inflation.
What is the economic intuition behind the Phillips curve during busts?
In busts: the reverse happens, low demand causes redundancies.
Suppose 5% inflation rate, firms may only raise prices by 3% to sell more, thus decreasing the growth rate of prices, decreasing inflation rate.
Okun’s Law equation
