The aggregate supply and phillips curve Flashcards
What is the aggregate supply curve formula?
P=Pe(u,z)(1+m) derived from the labour market equilibrium whereby price setting relation equals wage setting relation.
What causes AS curve to shift?
Changes in expected price, mark up and catch all variables
What shape is the MRAS curve and why?
Vertical because P=Pe and Y=Yn and U=Un
Why is the SRAS curve upward sloping?
What is the EAPC formula?
Inflation = Expected inflation + (mark up + catch all variables) - unemployment.
Explain each component of the EAPC formula?
Rise in expected inflation = rise in actual inflation as workers ask for rise in nominal wages translating to higher price. Increase in the mark up and catch all variables increases inflation. Decrease in unemployment leads to a rise in inflation as nominal wage increases which translates to a higher price.
What trade off was identified in the early days of EAPC?
Trade off between low inflation and low unemployment as there is an inverse relationship.
What shifts the EAPC curve?
Changes in the expected price level and mark up costs and catch all variables.
Why was the initial explanation of the trade off disproved?
in the early days inflationary expectations were derived on the basis that it wasnt persistent so inflation from the previous period wouldnt be a good indicator or expected inflation. Expectations were de-anchored when wage setters changed they= way they formed expectations as inflation became more persistent. It then changed again when MPC set an inflation target so any deviation from this people knew the CB would intervene to return it to 2% suggesting the PC curve should be horizontal.
Explain how inflationary expectations decrease the effectiveness of demand policies.
A demand policy to increase output will serve to decrease unemployment whilst tolerating the rise in inflation. As people expect g=higher inflation they demand higher wages which results in a rise in inflation by at least the expected amount. Firms costs go up translating to higher prices so the trade off can only be exploited temporarily as people will eventually adjust their expectations.
How does a) demand pull and b)supply/cost push inflation affect the AS curve.
Demand pull causes movement along the AS curve (fiscal and monetary useful here), cost push creates shift in the AS curve towards the medium run equilibrium (fiscal and monetary only useful to mitigate not prevent).
Disadvantages of inflation?
Money illusion; failure to figure out real term changes. Dilutes value of wealth and income. Shoe leather costs; cost to minimise cash holdings during times of high inflation as money value diminishes so may switch currencies. Resource misallocation - inflation distorts price signals. Decrease investments.
Advantages of inflation?
Dilutes gov debt and finances new spending. Decreases the chance of hitting the lower zero bound.
