Supply - Economic Forecasting - Lecture Slides, Slides of Economics

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Macroeconomic Models II:

Supply Side

Macroeconomy - Supply

Side

 Supply side of Macroeconomy consists of:

• Aggregate Production function relating output produced to inputs of labor and capital (machines and equipment)
• Supply and demand curves in Labor Market
• Labor Market equilibrium condition

 Short-cut to summarize all these pieces:

• Expectations Augmented Phillips Curve

Expectations Augmented

Phillips Curve: Slope

 In expectational equilibrium pt = (^) t-1pt. Hence U- UN = 0, regardless of the value of the inflation rate.

• in expectational equilibrium Phillips curve is vertical. (Long-run Phillips Curve (LP))

 Holding (^) t-1pt fixed, changes in unemployment rate produce changes in inflation in opposite direction (g < 0)

• Short-run Phillips curve (SP) is negatively sloped)

Long-run -- Short-run

Phillips Curves

p

UN U

LP

t-1pt SP

Long-run and Short-Run Phillips Curves intersect when actual inflation is equal to expected rate of inflation.

Unexpected Inflation vs

Unemployment: 1877-

Annual Unexpected Inflation vs Unemployment

0 5 10 15 20 25 30

**-

-** -

0

5

10

15

20

Long-run & Short-run Phillips

Curves in terms of Output (Y)

p

Y^ Y

N

LP

SP

t-1pt

p

UN^ U

LP

SP

t-1pt

or

Supply Shocks

 Think of changes in YN as “Supply Shocks”

• These can result from anything that changes productivity
• Also result from shifts in labor supply function

 Shocks to Yn affect both LP and SP curves

Changes in YN Shift Both LP

and SP Curves

p

Y

t-1pt

With no change in expected inflation, both SP and LP must shift when YN changes.

SP

LP

YN YN’

LP’

SP’