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1、CHAPTER 6AGGREGATE SUPPLY AND THE PHILLIPS CURVEChapter Outline The original and augmented Phillips curve Stagflation Rational expectations Reasons for wage and price stickiness The derivation of the AS-curve Supply shocks and policy responses Okuns law Political business cycles The sacrifice ratio
2、and the misery indexChanges from the Previous EditionOld Chapters 6 and 7 now have been divided into three separate chapters. The new Chapter 6 concentrates on the Phillips-curve and the unemployment-inflation tradeoff, while the following chapters deal exclusively with unemployment (Chapter 7) and
3、inflation (Chapter 8). Figures 6-1, 6-4, 6-6, 6-9 and 6-11 have been updated and old Figure 7-1 has been moved to this chapter and renumbered Figure 6-12. New Section 6-7 deals with the sacrifice ratio, the misery index, and the possibility of political business cycles, material previously covered i
4、n old Chapter 7. This section includes Table 6-1 (former Table 7-1), former Boxes 7-1 and 7-7 (now What More Do We Know? Boxes 6-1 and 6-2) and a new History Speaks Box 6-2. An appendix deriving the dynamic AS-curve has also been added.Introduction of the MaterialChapter 6 develops the price-output
5、relationship that determines the aggregate supply curve in more detail. Section 6-1 deals with the Phillips curve, which shows an empirical inverse relationship between the unemployment rate and changes in nominal wage rates and which can be expanded into a relationship between inflation and unemplo
6、yment. This implies that the Phillips curve and the AS-curve can be viewed as two alternative ways to study price adjustments. The old view of the Phillips curve suggested a clear policy trade-off between the rate of inflation and the unemployment rate. If this relationship held over time, policy de
7、cisionmakers could always choose the most desirable combination of unemployment and inflation along this curve. The basis for the Phillips curve is the observation that wages adjust only slowly to changes in the unemployment rate.The inflation-expectations-augmented Phillips curve is introduced in S
8、ection 6-2. Here it is assumed that inflationary expectations are constant in the short-run (along the downward-sloping Phillips curve), but whenever inflationary expectations increase, the short-run Phillips curve will shift to the right. Output is at its full-employment level only if expected infl
9、ation is equal toSolutions to the Problems in the TextbookConceptual Problems1. The aggregate supply curve and the Phillips curve describe very similar relationships and both curves can be used to analyze the same phenomena. The AS-curve shows a relationship between the price level and the level of
10、output, while the Phillips curve shows a relationship between the inflation and unemployment rates. For example, a movement along the upward- sloping AS-curve depicts an increase in the price level that is associated with an increase in the level of output. But Okunos law states that changes in outp
11、ut and the rate of unemployment are tightly linked. Therefore, with an increase in the price level (a higher level of inflation) there will be a higher level of output (a lower level of unemployment). Thus the AS-curve is upward sloping while the Phillips curve is downward-sloping. This downwardslop
12、ing Phillips curve shifts whenever inflationary expectations change. If one assumes that workers will change their wage demands whenever their inflationary expectations change, one can conclude that a shift in the Phillips curve corresponds to a shift in the upward- sloping AS-curve, since higher wa
13、ges imply a higher cost of production.The simple AD-AS diagram depicts a static framework, which relates changes in the price level to changes in output supplied or demanded. The Phillips-curve, on the other hand, depicts a dynamic framework in which percentage price changes (the rate of inflation)
14、are related to changes in the unemployment rate. Along the short-run Phillips-curve inflationary expectations are assumed to be constant. If one assumes that price expectations are constant along the upward-sloping AS-curve, the AD-AS framework becomes even more compatible with the Phillips curve fr
15、amework.2. The short-run Phillips curve is downward sloping, indicating that there is a trade-off between unemployment and inflation. This curve corresponds to the upward sloping AS-curve that shows an increase in the level of output as the price level increases. The long-run Phillips curve is assum
16、ed to be vertical at the natural rate of unemployment, which corresponds to the vertical long-run AS-curve at the full-employment level of output. Along the short-run Phillips-curve, inflationary expectations are assumed to be constant, and this short-run curve intersects the long-run Phillips curve
17、 at the natural unemployment rate. At this point, inflationary expectations are fulfilled.3. This chapter gives several explanations for the stickiness of wages in the short or medium run. One is that workers have imperfect information and do not know the actual price level. When nominal wages incre
18、ase to make up for a price increase, workers assume that their real wage rate has increased and thus they are willing to work more. Labor markets do not clear until workers realize their mistake. Another argument relies on coordination problems, that is, different firms within an economy cannot coor
19、dinate price changes in response to monetary policy changes. Individual firms change their prices only reluctantly, fearing loss of marketshare to competitors. Similarly, firms may be reluctant to cut wages since they are afraid that workers may leave. The efficiency wage theory argues that some fir
20、ms pay above marketclearing wages to motivate their employees to work harder. These firms are also reluctant to change prices because of the perceived menu costs involved. Since there are long-term relations between firms and workers and wages are usually set in nominal terms by wage contracts that
21、are renegotiated only periodically, real wage rates fluctuate over time as the price level changes. Not all wages are negotiated at the same time, so it takes time for wages (and subsequently prices) to adjust to an increase in money supply. Finally, the insideroutsider model argues that firms negot
22、iate only with their own employees but not with unemployed workers. Since a turnover in the labor force is costly to firms, they are willing to offer above market-clearing wages to their current employees rather than hiring the unemployed who may be willing to work for less.The various explanations
23、mentioned here are not mutually exclusive and differ mainly in their assumptions about how fast markets clear and whether employment variations are voluntary. It is up to students to decide which of the arguments they find most plausible.4. a. Stagflation is defined as a period of high unemployment
24、accompanied by high inflation.5. b. Stagflation can occur when people have high inflationary expectations. When the economy enters a recession, the rate of unemployment increases and the actual rate of inflation falls below the rate that was expected. But even if the unemployment rate is high, the a
25、ctual inflation rate can still be very high as well. For example, if a supply shock occurs, the rate of unemployment increases along with inflationary expectations, so the short-run Phillips curve shifts to the right. If the Fed has let money supply grow too fast in the past, and is expected to resp
26、ond to the supply shock by expanding money supply further, everyone expects that the inflation rate will remain very high even at fairly high unemployment rates. This scenario occurred during the 1970s. In such a situation, policies must be designed to reduce inflationary expectations, so the short-
27、run Phillips curve can shift back to the left. However, such policies are not easily implemented. Since actual inflation is below expected inflation, inflationary expectations adjust downward over time and the economy eventually settles back at the natural rate of unemployment. Unfortunately, this p
28、rocess can be very lengthy and stagflation should be avoidedAssume a disturbance occurs and the AD-curve shifts to the right. Unemployment decreases and inflation increases and we move along the short-run Phillips curve to the left. However, as people realize that actual inflation is higher than the
29、ir inflationary expectations, they adjust their expectations upward and the short-run Phillips curve shifts to the right, eventually returning unemployment back to its natural rate. In other words, the economy adjusts back at the full-employment level of output.If an adverse supply shock occurs, une
30、mployment and inflation increase simultaneously. In this case, the shift of the short-run Phillips curve to the right corresponds to a shift of the upward-sloping AS-curve to the left. People eventually realize that actual inflation is lessthan expected inflation, so they adjust their inflationary e
31、xpectations downward. As a result, the short-run Phillips curve shifts back to the left and the economy adjusts back to the natural rate of unemployment in the long run.6. The original expectations-augmented Phillips curve predicts that inflation will rise above the expected level when unemployment
32、drops below its natural rate. In other words, the location of the expectations-augmented Phillips curve is determined by the level of expected inflation. However, if people know that inflation will rise why dont they immediately adjust? And if people immediately adjusted, wouldnt this imply that ant
33、icipated monetary policy would be ineffective in causing deviations from the full-employment level of output?The rational expectations model assumes that the short-run Phillips curve shifts almost instantaneously as new information about the near future becomes available. However, in reality, even i
34、f people have rational expectations, they may not be able to adjust immediately. One reason is that wage contracts often set wages for extended periods of time, so changes needed to reach a new long-run equilibrium cannot be made quickly. Similarly, firms may not always change prices right away, sin
35、ce the costs of doing so may outweigh the benefits. A further argument is that even rational people make forecasting mistakes and need time to recognize their errors. Therefore many economists believe that expected inflation is determined by recent historical experience, and that a shift in the shor
36、t-run Phillips curve caused by changing inflationary expectations occurs only gradually.7. The sacrifice ratio is the percentage of output lost for each one-percent reduction in the inflation rate. It is non-zero in the short and medium runs, when output is not at the fullemployment level. But in th
37、e long run, the unemployment rate always returns to its natural level, that is, output returns to the full-employment level. This implies that the sacrifice ratio is zero in the long run.Technical Problems1. A reduction in the supply of money leads to excess demand for money and increased interest r
38、ates, reducing the level of private spending (especially investment). Therefore the AD-curve shifts to the left. This causes an excess supply of goods and services at the original price level so the price level starts to decrease. Since the AS-curve is upward sloping, a new short-run macro-equilibri
39、um is reached at a lower level of output (and therefore a higher level of unemployment) and a lower price level.However, the higher level of unemployment eventually provides downward pressure on wages, reducing the cost of production and shifting the upward-sloping AS-curve to the right. Alternative
40、ly, since this short-run equilibrium output level is below the full-employment level, prices will continue to fall and the upward-sloping AS-curve will shift to the right. As long as output is below the full-employment level Y； the upward-sloping AS-curve will continue to shift to the right, which m
41、eans that the price level will continue to decline.Eventually a new long-run equilibrium will be reached at the full-employment level of output (Y) and a lower price level.0Yi Y*YMsU in lU YU AD u Ex.S. PU real ms ft iU lit Y ftShort-run Effect: Y U UR ft P U i IT2.-3. UR ft WU cost of prod. U AS n
42、Ex.S. PU real ms ft iU I ft Y ft Long-run Effect: Y = const. UR = const. P U i = const.2. The rational expectations theory predicts that an announced change in monetary policy will immediately change peoples expectations about the inflation rate. If people could adjust immediately to this change in
43、inflationary expectations, the rate of unemployment and output would remain at the full-employment level. In this hypothetical situation, any announced monetary policy change would not affect the unemployment rate. In other words, we would move immediately from point 1 to point 3 in the diagram that
44、 was used to explain the previous question. But even if people have rational expectations and can anticipate the effects of a policy change correctly, they may not be able to immediately adjust due to wage contracts, etc, Thus, there will always be some deviation from the full-employment output leve
45、l Y*. In the above diagram, the AS-curve would start shifting to the right much earlier and we would end up somewhere between points 1 and 3 and even with an anticipated policy change we would have some increase in unemployment.3a A favorable supply shock, such as a decline in material prices, shift
46、s the upward-sloping AS- curve to the right, leading to excess supply at the existing price level. A new short-run equilibrium is reached at a higher level of output and a lower price level. But since output is now above the full-employment level, there is upward pressure on wages and prices and the
47、 upward-sloping AS-curve starts shifting back to the left. A new long-run equilibrium is reached back at the original position at Y and the original price level (assuming that the90change in material prices did not affect the full-employment level of output). Since nominal wages (W) will have risen
48、but the price level (P) will not have changed, real wages (W/P) will have increased.PPoPi0PPoPi0ASiY* YiY3b Lower material prices lower the cost of production, shifting the upward-sloping AS-curve to the right. This leads to an increase in output and a lower price level. Since unemployment is below
49、its natural rate, there is a shortage of labor, providing upward pressure on wages. But higher wages will increase the cost of production again, so the upward-sloping AS-curve will eventually shift back to the original long-run equilibrium (assuming that potential GDP has not been affected). The adjustment process can be described as follows:12: material prices = cost of production 1 = the AS-curve shifts right= excess supply = P = real ms T = i = I