Unit 5

Unit 5
• Short Run aggregate Supply
- The period in which wages (+ other $’s) remain fixed as price level increases or decreases
• Long Run As
- Period of time in which wages have become fully responsive to changes in Pl.
• Effects over short run
- In SR , price level changes allow for companies to exceed normal outputs and hire more workers because profits are increasing while wages remain constant .
- In LR , 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 the short run and LRAS curves
- The LRAS curve is represented with a vertical line and full employment level of real GDP.
• Demand pull inflation in the AS. Model
- Demand Pull prices increase based on increase in AD
- In the SR , demand pull drive up prices , and increase production
- In the LR , increases in the aggregate demand will eventually return to previous levels.
• Cost push and the extended model
- CP arises from factors that will increase per unit costs such as increase in the price of a key source
- Short run shifts left. What is important is that this case, it is the cause of the PL increase, not the effect.
• Dilemma for the government
- in an effect to Fight cost push, the government can react in 2 ways
- Action such as spending by the government could begin an inflationary spiral
- No action however could lead to a recession by keeping production and employment levels declining


4/8/16

• THE PHILLIPS CURVE
- the long run Phillips curve
*note – The Natural rate of unemployment is held constant





- Because the LRPC exists at the natural rate of unemployment
(Un) , structural changes in the economy that effect un, will also cause the LRPC to shift.
- Increase in un, will shift LRPC >
- Decrease in un, will shift LRPC <


Assume that the US economy is in long run equilibrium with an expected inflation rate of 6 percent and an unemployment rate of 5 percent. The nominal interest rate is 8 percent


B) i% = n% - Ti %
          = 8% - 6%
          = 2%
C) buy bonds


4/11/16

• INFLATION- a general rise in the price level
• DEFLATION- a general decline in the price level
• DISINFLATION- a decrease inflation rate over time.
• STAGFLATION- unemployment and inflation increasing at the same time.


4/13/16

SUPPLY SIDE ECONOMICS- change AS not AD. Determines the level of inflation, unemployment rates, and economic growth
SUPPLY SIDE ECONOMIC – support policies that promote GDP growth by arguing that high marginal  tax rates along with the current system of transfer payments such as unemployment compensation or warfare programs , provide disincentive to work , save , innovate , and undertake enterperal ventures.

Lower Marginal tax rates – induce more work , this causes as to increase. Al6 makes leisure more expensive, and work more attractive.

INCENTIVE TO SAVE AND INVEST
1. High marginal tax rates reduce the rewards for saving and investment.
2. Consumption might increase , but investment depends upon savings
3. Lower marginal tax rates encourage savings and investment

LAFFER CURVE
- Theoretical relationship between tax rates and government revenue.
- As tax rates increase from 0 , government revenues increase increase from 0 to
- Criticisms :
1. Research suggests that the impact of tax rates on incentives to work , save , and invest are small.
2. Tax units also increase demand, which can fuel inflation, and demand may exceed supply
3. Where the economy is actually located on the curve , is difficult to determine


4/26/16

• BALANCE OF PAYMENTS – measure of money inflows and outflows between then US and the post of the world (grow)
- Inflows = credits
- Outflows = debits
• The balance of payments is divided into 3 accounts

1. Current account
2. Capital / financial account
3. Official reserves account

• Double entry bookkeeping
• Current account
- Balance of trade or net exports
- Exports of goods / services-import of goods /services
- Exports create a credit to the balance of payments
- Imports create a debit to the balance of payments

• Net foreign
- Income earned by US owed foreign assets – income paid to foreign held US assets
- Ex: interest payments on US own Brazilian bonds – interests payments on German owed US  treaty bonds
• Net transfer (tend to be unilateral)
- foreign aid > a debit  to the current account
- Ex : Mex . Migrant workers send $ to farm in Mexico.

CAPITAL/ FINANCIAL ACCOUNT
• The balance of capital ownership
• Includes the purchase of both real and financial assets
• Direct investment in the US is a credit to the capital account
- Toyota factory in San Antonio (EX)
• Direct investment in the US firms (individual in a foreign country are debits to the capital account
- the Intel factory in San Jose , Costa Rica
• Purchase of domestics financial assets by foreigners represents a credit to the capital account
- The United Arab Emirates Sovereign wealth funds purchases a large stake in the NASDAQ
        RELATIONSHIP BETWEEN CURRENT AND CAPITAL ACCOUNT
- double entry bookkeeping
- The current account and capital account should sew each other out
- That is…. If the current account has a negative balance (DefIcit)
Then the capital account should

OFFICIAL RESERVES
- The current foreign currency holdings of the US federal reserve system
- When there is a balance of payments supply the federal accumulate foreign currency and debits the balance of payments
- When there is reserves of foreign currency and credits the balance of payments
- The official reserves sew out the balance of payments

ACTIVE VS. PASSIVE OFFICIAL RESERVES
• The US is passive in its use of official reserves. It dives not seek to manipulate the dollar exchange rate
• The people republic of China is active in its use of official reserves. It actively buys and sells dollars In order to maintain a steady exchange rate with the US

4/27/16
         BALANCE OF TRADE
            Goods             +             Goods
            Exports                           Imports

BALANCE ON GOODS AND SERVICES
             Goods           +                Service         +            Goods
              Exports                           Exports                      Imports