Recap of EC107/108 Flashcards
What is the equation for the IS curve?
y = A - ar
What does A and ar stand for in the IS equation?
A = autonomous consumption ar = the -ve impact of r on investment
What are the issues with the IS model? What assumptions does it make?
1) Consumption is only shown to be dependent on taxation and not interest rates
2) Investment is only dependent on the interest rate and not levels of income
What is the shape of the IS curve and what does this show about the relationship between r and y?
It is downward sloping -> as r decreases output increases
What are the properties of the IS curve?
It is downward sloping
A change in the multiplier changes the slope
A change in investment sensitivity to r changes the slope
A change in (A) will shift the curve
What does the Dynamic IS curve capture and how is that different to the regular IS curve?
It captures the reality that there is a one period lag between a change and r and the effect that that will have on investment and GDP
What is the equation of the Dynamic IS curve?
Yt = A - ar(t-1)
What does the Phillips curve capture the relationship between?
Inflation and expected inflation
What is the equation for the PC?
inflation = last period’s inflation + A(output gap)
What do prices change in accordance to in the PC?
Nominal wages -> as nominal wages increase, prices increase
What could cause a change in nominal wages in the PC?
A +ve or -ve output gap
What is the shape of the PC in inflation-y space?
It is positively sloping -> when output exceeds equil. output then inflation increases
Where do the foundations of the PC lie in?
The labour market
What is the relation of inflation to unemployment?
As unemployment increases, inflation will fall
What causes the PC to shift?
Changes in the labour market
Why do firms set wage above a worker’s reservation wage?
To induce effort
How does the level of unemployment impact the cost of job loss?
At high unemployment, the cost of job loss is higher
At low unemployment, the cost of job loss is lower
What do firms set wage at in perfectly competitive markets?
They will set wage at the opportunity cost of working (reservation wage)
How do output gaps affect the wage and WS curve?
A positive output gap will see employment increase and as such increases pressure on nominal wage
A negative output gap will see employment decrease and will decrease pressure on nominal wages
In a closed economy, what are the sources of supply shocks?
Shifts in WS or PS
What is the difference between real product wage and real consumption wage?
Real product wage (W/P) is before tax and real consumption wage (W/Pe) is after tax
What 2 factors can cause WS to shift?
Efficiency wage factors
Union-related factors
What are examples of efficiency wage factors that shift WS?
A fall in unemployment benefits
An improvement in working conditions -> increases the cost of unemployment
What are examples of union-related factors that shift WS?
Less legal protection for unions
A reduction in union bargaining power
Unions exercising more bargaining restraint
What does the gap between WS and the opportunity cost of working consist of?
1) real wage mark-up required to incentivise worker effort
2) the mark-up coming from worker bargaining power
For the PS curve equation:
Check slides
PS changes depend on what?
+vely on wage changes
-vely on productivity changes
What will cause the PS to be flat?
If there is a constant MPL -> when labour productivity is constant
What is the PS negatively marked up under?
Productivity -> PS is equal to productivity minus the mark-up of productivity over the wage set
What are examples of price push factors?
1) a fall in the tax wedge
2) a fall in the mark-up e.g. due to tougher competition rules
3) a rise in productivity
For maths about price changes and the PS equation?
Check notes
What will the CB need to do to make best policy predictions?
Predict the PC so that they know where the economy will be in the next periods
What is the CB constrained by?
The PC
What does beta stand for in the CB loss function equation?
The level of aversion to inflation
What do the CB’s isoquants represent?
The CB’s preferences relating to inflation and output
What does the PC show the CB?
The variations of inflation and output attainable for a given inflation expectation
Where will the CB’s optimal response be?
Where the PC is at a tangent to the CB isoquants
What does the MR show?
The ideal combinations of inflation and output for any PC that the CB may face
What does the CB do once they have identified their ideal output gap?
They read of the IS to figure out what r is needed to achieve that output gap
What does the CB need to take into consideration when setting r?
That there is a one period lag between the change in r and the effect on GDP
What does the CB need to do to overcome the one-period lag from a change in r?
Forecast inflation and output for the next period so that they know what the ideal r will be
