9 - macro econ

• Short Run

  Factor prices are assumed to be exogenous; they may change, but any change is not explained within the model. Technology and factor supplies are assumed to be constant (and therefore Y* is constant).
• Adjustment Process

  Factor prices are assumed to adjust in response to output gaps. Technology and factor supplies are assumed to be constant (and therefore Y* is constant).
• Long Run

  Factor prices are assumed to have fully adjusted to any output gap. Technology and factor supplies are assumed to be changing.
• Three Macroeconomic States

  • Short Run
  • Adjustment Process
  • Long Run
• Short Run

  • Real GDP (Y) is determined by aggregate demand and aggregate supply.
• Adjustment Process

  • Factor prices adjust to output gaps; real GDP eventually returns to Y*.
• Long Run

  • Potential GDP (Y*) grows over the long run.
• Output above potential, Y > Y*

  Excess demand for all factor inputs, upward pressure on wages
• Output below potential, Y < Y*

  Excess supply of all factor inputs, downward pressure on wages
• Booms can cause wages to rise rapidly, recessions usually cause wages to fall only slowly
• Phillips Curve

  Negative relationship between unemployment and the rate of change in wages
• Following an AD or AS shock

  Short-run equilibrium level of output may be different from potential output,

  but output gap causes wages and other factor prices to adjust,

  eventually bringing the equilibrium level of output back to potential

  
  

  Thus we call Y* an anchor
• Positive AD shock

  Increases real GDP and price level in the short run, but real GDP returns to potential output in the long run
• Negative AD shock

  Decreases real GDP and price level in the short run, but real GDP returns to potential output in the long run
• Negative AS shock

  Decreases real GDP and increases price level in the short run, but real GDP returns to potential output in the long run
• Long-run equilibrium occurs when the intersection of the AD and AS curves is at Y*
• Shift in AD curve

  Raises price level but leaves real GDP unchanged in the long run
• Increase in potential output

  Raises real GDP and lowers the price level
• Canadian data confirm that positive output gaps tend to drive wages and costs upward, and negative output gaps tend to drive wages and costs downward
• Fiscal Stabilization Policy

  Government uses fiscal tools to push real GDP back towards potential output

  
  

  alternative is just to wait until it happens naturally, wait for recovery an adjustment period
• Effect of shift in AD

  Divided between change in Y and change in P, with steeper AS curve leading to greater price effect and smaller output effect
• Negative supply shock

  Shifts AS curve leftward, rise in price level shifts AE curve downward
• Paradox of thrift - increase in saving reduces real GDP in short run, but increases investment and potential output in long run
• Automatic Fiscal Stabilizers

  Tax-and-transfer system reduces value of multiplier and acts as automatic stabilizer, with rise in net tax revenues dampening increase in real GDP from AD shock
• Lower net tax rate (t) leads to larger simple multiplier and less stable real GDP in response to shocks
• Increase in government purchases can increase potential output or its growth rate, reducing negative effects from crowding out of private investment
• Reductions in tax rates generate short-run demand stimulus and may also generate longer-run increase in level and growth rate of potential output
• fill in

  A) exogenous

  B) endogenous

  C) endogenous

  D) or adjusted

  E) factor prices

  F) returns

  G) changing

  H) constant/exogenous

  I) constant/exogenous

  J) By AD and AS

  K) grows

  L) shocks

  M) change

  N) return

  O) nature

  
• Adjustment process

  A) recessionary

  B) inflationary

  
• Y>Y*

  • excess demand of inputs - producing beyond capacity
  • workers will put upward pressure on wages w/ newfound bargaining power
  • conditions: high profits for firm and excess demand for labour
• Y<Y*

  • excess supply inputs - producing below normal capacity
  • below normal sales = no upward pressure on wages but maybe reduction in wages
  • conditions: low profits for firm and an excess supply of labour
• Downward wage Stickiness

  • Booms can cause wages to rise rapidly.
  • Recessions usually cause wages to fall only slowly
• Automatic stabilizer

  • Suppose a shock shifts AD right and increases short-run
  • As real GDP increases, government tax revenues also increase.
  • With fewer low-income households and unemployed persons requiring assistance, governments transfers fall.
  • The rise in net tax revenues dampens the overall increase in real GDP caused by the initial shock.
• Limitations of Discretionary Fiscal Policy

  • Decision and Execution Lags• Temporary versus Permanent Tax Changes

  • Fine Tuning versus Gross Tuning
• • The marginal propensity to spend on national income is:z = MPC(1 – t) – m
• • The simple multiplier is:Simple multiplier = 1/ (1 – z)
• • The lower the net tax rate (t), the larger the simple multiplier and thus the less stable is real GDP in response to shocks to autonomous spending
• • In the long run, the path of real GDP is determined by the path of potential output
• • The increase in saving has the long-run effect of increasing investment and therefore increasing potential output.
• fill

  A) Price level

  B) inflationary

  C) inflationary

  D) Price level