Unit 5

Unit 5

Unit 5
Short run aggregate supply 
-  In macroeconomics this is the period in which wages and other input prices remain fixed as price level increases or decreases. 

Long Run aggregate supply 
- Period of time in which wages have become fully responsive to chafes in price level. 

Effect over Short - Run 

-  In the short run, price level changes allow for companies to exceed normal outputs and hire more workers because profits are increasing while wages remain constant. 

-  In the long run, wages will adjust to the price level and previous output levels will adjust accordingly. 

Equilibrium in the extended model 

-  The extended model means the inclusion of both short run and long run AS curves. 

-  The long AS curve is represented with s vertical line @ full employment 

      Demand pull Inflation. 
Demand pull - prices increase based on increase in aggregate demand 

In the short run, demand pull will drive up prices, and increase production 

In the long run, increases in aggregate demand will eventually return to previous levels. 

Cost push inflation and extended model 

Cost push arises from factors that will increase per unit cost such as increase in the price of a key resource. 

Short run shifts left. What Is important is that in this case, it is the cause of the price level increase, not the effect. 

   Dilemma for the Government
In an effort to fight cost-push, the government can react in two different ways.  
- Action such as spending by the Govt could begin an inflationary spiral 
- No action however could lead to recession by keeping production and employment levels declining. 


Because the long run Philips curve existed at a natural Rae of unemployment(Un) structural changes in the economy that affect Un will  also cause the LRPC to shift

Inflation - general rise in the price level 
Deflation - general decline in price level 

Disinflation - decrease in inflation or in the rate of inflation over time 

Regannomics 
Changes As And not Ad. It determines the level of inflation, unemployment rate and economic growth. 

Supply side economist support polices that promote GDP growth by arguing that high marginal tax rate along with the current system of transfer payment such as unemployment compensation and welfare programs provide disincentive to work, save, innovate and undertake entrepreneur. 

Lower Marginal Tax rate induce more work causing AS to increase. They also make leisure more expensive and work more attractive 

Incentives to save and invest 
1. High marginal tax rates- reduce the reward for saving and investment 
2. Consumption might increase but investment depends upon savings 
3. Lower marginal tax rate encourage saving and investments. 

Laffet Curve 
There is a theoretical relationship between tax rates and governments revenue as tax rates increase from 0 government revenues increase from 0 to some maximum level and then decline 

First criticism 
Research suggest that the impact of tax on incentives to work save and invest are small. 

Second criticism 
Tax cuts also increase demand which can fuel inflation and demand may exceed supply 

Where the economy is actually located in the curve is difficult to determine