Stocks and Bonds
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Chapter 16: Extending the Analysis of Aggregate Supply
From Short Run to Long Run
* Short-run: a period in which nominal wages (and other input prices) do not respond to price level changes.
* Workers may not be fully aware of the change in their real wages due to inflation (or deflation) and thus have not adjusted their labor supply decisions and wage demands accordingly.
* Employees hired under fixed wage contracts must wait to renegotiate regardless of changes in the price level.
* Long-run: a period in which nominal wages are fully responsive to previous changes in price level
* Short-run aggregate supply curve: three assumptions:
* The initial price level is given at P1.
* Nominal wages have been established on the expectation that this specific price level will persist.
* The price level is flexible both upward and downward.
* If the price level rises, higher product prices with constant wages will bring higher profits and increased output.
* If the price level falls, lower product price with constant wages will bring lower profits and decreased output.
Applying the Extended AD-AS Model
* Demand-pull inflation: In the short run it drives up the price level and increases real output; in the long run, only price level rises.
* Cost push inflation arises from factors that increase the cost of production at each price level; the increase in the price of a key resource, for example. This shifts the short run supply to the left, not as a response to a price level increase, but as its initiating cause. Cost-push inflation creates a dilemma for policymakers.
* If government attempts to maintain full employment when there is cost-push inflation an inflationary spiral may occur.
* If government takes a hands-off approach to cost push inflation, a recession will occur.The recession may eventually undo the initial rise in per unit production costs, but in the meantime...
From Short Run to Long Run
* Short-run: a period in which nominal wages (and other input prices) do not respond to price level changes.
* Workers may not be fully aware of the change in their real wages due to inflation (or deflation) and thus have not adjusted their labor supply decisions and wage demands accordingly.
* Employees hired under fixed wage contracts must wait to renegotiate regardless of changes in the price level.
* Long-run: a period in which nominal wages are fully responsive to previous changes in price level
* Short-run aggregate supply curve: three assumptions:
* The initial price level is given at P1.
* Nominal wages have been established on the expectation that this specific price level will persist.
* The price level is flexible both upward and downward.
* If the price level rises, higher product prices with constant wages will bring higher profits and increased output.
* If the price level falls, lower product price with constant wages will bring lower profits and decreased output.
Applying the Extended AD-AS Model
* Demand-pull inflation: In the short run it drives up the price level and increases real output; in the long run, only price level rises.
* Cost push inflation arises from factors that increase the cost of production at each price level; the increase in the price of a key resource, for example. This shifts the short run supply to the left, not as a response to a price level increase, but as its initiating cause. Cost-push inflation creates a dilemma for policymakers.
* If government attempts to maintain full employment when there is cost-push inflation an inflationary spiral may occur.
* If government takes a hands-off approach to cost push inflation, a recession will occur.The recession may eventually undo the initial rise in per unit production costs, but in the meantime...