-Nominal Wages: the amount of money received per hour, per day, or per year.
-Sticky Wages: this is where the nominal wage level is set according to an initial price level and does not vary.
-Time is too short for wages to adjust to the price level.
-Workers may not be aware of changes in their real wages due to inflation and have adjusted their labor supply decisions and wage demand accordingly.
Price level
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Wage level
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Employment level
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Implications
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Keynesian/Horizontal
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Fixed
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Fixed
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Flexible
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Dep. On change in employment.
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Intermediate
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Flexible
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Fixed
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Flexible
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Dep. On change in price level and employment.
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Classical or Vertical
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Flexible
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Fixed
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Fixed
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Dep. On change in price level.
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Long run aggregate supply (LRAS)
-Flexible price level and wage
-Time long enough for wages to adjust to the price level
-Both offset each other
*Phillips curve represents the relationship between unemployment and inflation.*
-Trade off between inflation and unemployment that only occurs in the short run.
Long run Phillips curve:
-occurs at the natural rate of unemployment represented by a vertical line at 4-5 %.
-There is no trade off between unemployment and inflation in the long run which means that the economy produces at the full employment level.
-The long run phillips curve will only shift if the LRAS curve shifts, otherwise it is assumed to be stable.
-Trade off between inflation and unemployment that only occurs in the short run.
Long run Phillips curve:
-occurs at the natural rate of unemployment represented by a vertical line at 4-5 %.
-There is no trade off between unemployment and inflation in the long run which means that the economy produces at the full employment level.
-The long run phillips curve will only shift if the LRAS curve shifts, otherwise it is assumed to be stable.
NRU = Seasonal, Frictional, Structural
Major LRAS assumption:
-The more worker benefits create higher natural rates and fewer worker benefits create lower natural rates.
Short run phillips curve:
-Inverse relationship between unemployment and inflation.
-It has relevance to Okuns law
-Since wages are sticky inflation changes, moves the points on the SRPC.
-If inflation persist and the expected rate of inflation rises, than the entire SRPC moves upwards causing stagflation.
-If inflation expectations drop due to new technology or economic growth then the SRPC moves downwards.
Aggregate supply shocks cause both the rate of inflation and the rate if unemployment to increase.
Supply shock - rapid and significant increase in resource cost.
Misery index: the combination of inflation and unemployment in any given year.
-If inflation expectations drop due to new technology or economic growth then the SRPC moves downwards.
Aggregate supply shocks cause both the rate of inflation and the rate if unemployment to increase.
Supply shock - rapid and significant increase in resource cost.
Misery index: the combination of inflation and unemployment in any given year.
-Single digit misery is good
The Long Run Phillips Curve
-Because long run Philips curve exists at the natural rate of unemployment, structural changes in the economy that affect unemployment will also cause LRPC to shit
-Increase in unemployment will shift LRPC to the right
-Decrease in unemployment will shift LRPC to the left
*SRAS and SRPC are opposite*
-Increase in unemployment will shift LRPC to the right
-Decrease in unemployment will shift LRPC to the left
*SRAS and SRPC are opposite*
Stagflation: A period of high inflation and high unemployment occurring at the same time.
EX. Baby boom
Women's movement
Civil rights movement
Vietnam war ends
Oil embargo of 1973 and 1979
Disinflation:Reduction in the inflation rate from year to year
-Nominal wages increase during this time
Deflation: A situation in which there is an drop in the price level.
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