Econ 4.3

Friday, April 2, 1999

Announcements: There will be review session in 262 Willard on Tuesday, 4/6, from 6:30 to 8 pm. The exam is Wednesday, 4/7.

Lecture notes:  

Why Does AD slope downward?

• Aggregate demand falls when the price level increases because the higher price level causes the demand for money (Md) to rise. With the money supply constant, the interest rate will rise to reestablish equilbrium in the money market. It is the higher interest rate that causes aggregate output to fall.
• Other reasons:
• Consumption Link
• Real Wealth (real balance) effect
• Shifting AD -- change in Money Supply (see Figure 14.3 on page 296)
• An increase in money supply expands money supply and shifts AD to the right and vice versa
• See Figure 14.5 on page 297
• Changes in G or T
• Expansionary Fiscal Policy: Increase G, decrease T
• Shift by equal amount: cut taxes more than incrase spending because tax multiplier is less than G multiplier

• Expansionary Monetary Policy
  • MP increases -> AD curve shifts to the right
• Expansionary Fiscal Policy
  • G increases -> AD curve shifts to right
  • T decreases -> AD curve shifts to the right
• Contractionary Monetary Policy
  • G decreases -> AD curve shifts to the left
  • T increases -> AD curve shifts to left
• Aggregate Supply
  • Represents the total supply of all goods and services in an economy
• AS Curve (in Short Run)
  • Supply curve rises as general prices rise

Shifts

• Costs Shocks
  • Fundamentally alters costs of productoin
  • Minimum wage -> raise by sign. amount -- alters production -- shifts to the left and up or: small amount LF earn MW -- no effect
• Economic Growth
  • Investment capital shifts to the right
• Stagnation
  • Occurs -- failure of new investment capital stock deteriorates -- productivity capital decreases. Net investment is negative
• Public Policy
  • enacted -- build highway sometimes stops productions -> interfering with market -> tobacco - increase taxes, unatractive to buyers, production lose sales with price increases -- Surgeon General Warning on smokers buyers tend to buy less -- land prices -- alotment of Tobacco - expensive by keeping down supply
• Natural Disasters
  • Destroy capital and capital stock decreases

• See Figure 14.11 on page 306
• Price level tends to increase
• US right now has a 1.3% price increase per year
• Acceptable level: what people are willing to accept or tolerate
• Acceptable price level's percent incrase varies from time to time (over different eras)

• Why is it argued that inflation is essentially a monetary phenomenom?
• 1) Demand Pull (inflation): Something that shifted D curve to the right increases Price level
• 2) Cost Push (inflation): Something that raises general cost -- child labor work laws
• See figure 14.14 on page 311

• How does inflation get started with little change in real output?
• Most labor forces are unionized
• An increase in wages is greater than the rate of productivity -- it raises income
• Escalated cost of living -> workers are unhappy because their money won't buy them what they thought
• Because of inflation in this economy there is an increase in wages -- an increase in costs equilibrium reamins at the same point, but price levels keep rising
• Indexing salaries and wages to inflation rate -> to maintain costs and equilibrium
• Indexing tax brackets when income and prices rise then people remain in same brackets so they aren't hurt by inflation

Investors

• Bond - inflation index rate bond
• Indexing -> insulate people from inflation