Aggregate Supply Flashcards
Y = Aggregate supply =
YBAR - a (P – EP)
YBAR - a (P – EP) This equation shows that when Y is different from YBAR _____
prices will change
EP
expected price
P
is the actual price
so EP should be equal to P otherwise
P will change
alpha(a) is a positive
parameter
YBAR is the natural rate
of output
P =
= EP + 1/a (Y – YBAR)
If Y>YBAR
we expect EP to be higher than P as we expect prices to rise
If EP increases
then the firms will raise their prices as well
Reasons for sticky price
ong-term contract between firms and customers – menu
costs (such as cost of replacing the labels) – firms not wishing to annoy customers
with constant price change
In the sticky price model, they set price equal to the ______ and ______of output
expected output, natural
rate
s =
the number of firms with sticky price model which is between 0-1
P = s [EP] (1+s) [P−a (Y + Y)]
this is the average price for the economy
EP level can go up for many reasons
such as going to war so G will increase – or
these is a drought so supply will fall
Imperfect information model – assumption made are:
All wages and prices are flexible
- Supplier produces one good and consumers consume many
- Supplier knows the nominal price level of its product but not the overall price
leve
the EP price has risen which is why they are buying
more as the apples are relatively cheaper
in the long-run suppliers will actually increase price and reduce
production – as they cannot supply equal to the demand
In the long run supply will always be equal to
Y = F (K, L)
In the long run supply is on Ybar when
n K and
L are at full employment
so if the price at a certain level that is where quantity is and
that is what is supplied
If we know the expected price, then we cannot draw a SRAS curve because suppliers
will make sure price is equal
to expected price
If price is higher than expected price – and we assume the sticky-wage theory
then
workers have already signed contracts – so prices will be higher, and wages remain
the same – this will mean labour is cheaper so will hire more workers
SRAS curve to shift back at a higher price
– this is stagflation
P - P-1 = LnP – LnP-1 = ∆P/P =
inflation rate
If we cut money supply and increase the OCR
this will
increase employment and lower the inflation as the AD falls
Philips Curve =
u = un – (1/ß) (π – Eπ)
The shift in the demand curve is mainly caused by a change in _____
money demand
demand curve is
is the SRPC
Adaptive inflation is
people assuming inflation based on past figures so Eπ = π-1
π = π−1 −β (u −un)
this is the inflation inertia suggesting that without any shocks in
the economy inflation will continue at the same rate
Cost push inflation
– inflation resulting in supply shocks – adverse supply shock
raising production costs causing prices to rise such as drought
Demand pull inflation
inflation due to demand shocks – upward pull of the
demand curve as money demand is high
n the short run it is assumed that Eπ
remains the same
In order to get the expected inflation rate we look at what the inflation rate
would be at
u = un
In the long run unemployment is equal to the natural rate of unemployment
which represents the LRPC
If Eπ increases
this will shift the SRPC upwards
