Recap of 3 eq model Flashcards
What is the IS Curve formula
Yt = A - a r(t-1)
What does the IS curve depict
Current real demand in terms of past real interest rate
Properties of the IS curve
- depicts goods market equilibrium
- downward sloping
- change in multiplier changes the slope (high multiplier, flat IS curve)
- change in investment sensitivity to interest rate changes the slope (high sensitivity, flat IS curve)
Shifts in the IS curve
- change in c0, I, a0, G
By how much does IS curve shift?
multiplier X change in spending
What is the Philips curve formula?
π1 = π0 + α(y1 − ye)
Where π0 is lagged inflation and ye is equilibrium output. This is the adaptive expectations form.
What does the Philips curve depict?
Initially, it was used to depict the inverse relationship between unemployment and inflation. Now, using Okun’s law, it depicts the positive relationship between inflation and output.
What shifts the Philips curve?
Since the adaptive expectation theory is used, changes in lagged inflation shift the curve up or down.
What is the Philips curve used for?
The PC acts as a constraint for policy makers when optimising inflation & output (all feasible combinations of inflation and output).
What is the wage setting equation?
Ws = W/ pe = B(N, zw)
Where pe is expected prices and zw are wage push factors.
What shifts the wage setting curve?
Wage push factors such as:
- efficiency wage factors (improvement in working conditions, benefits for unemployed)
- union-related factors (less legal protection for unions)
How is price determined?
𝑃= (1+𝜇) W/ λ,
where λ= level of productivity
𝜇 = mark up
What is the price setting equation?
Wps = λ F(𝜇, zp)
Where zp are price push factors
What shifts the PS curve?
Price push factors such as (push it upwards):
- fall in mark up
- rise in productivity λ
- fall in the tax wedge
What is the relationship between price growth and wage growth?
Price growth = Wage growth - productivity growth
Δp/p = Δw/w - Δλ/λ
