ECON-1007EL Chapter Notes - Chapter 24: Output Gap, Phillips Curve, Large Deviations Theory
22 May 2018
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Chapter 24: From the Short Run to the Long Run
Definitions
Phillips Curve
Originally, a relationship between the unemployment rate and the rate of change of
nominal wages. Now often drawn as the relationship between GDP and the rate of
change of nominal wages
Automatic
Stabilizers
Elements of the tax-and-transfer system that reduce the responsiveness of real GDP to
changes in autonomous expenditure
Decision Lag
The period of time between perceiving the problem and reaching a decision on what
to do about it
Execution Lag
The time that it takes to put policies in place after a decision has been made
Fine Tuning
The attempt to maintain output as its potential level by means of frequent changes in
fiscal policy or monetary policy
Gross Tuning
The use of macroeconomic policy to stabilize the economy such that large deviations
from potential output do not persist for extended periods of time.
Three Macroeconomic States
The Short Run
The Adjustment Process
The Long Run
Key
Assumptions
Factor prices are
exogenous.
Technology and factor
supplies (and this Y*) are
constant/exogenous.
Factor prices are
flexible/endogenous.
Technology and factor
supplies (and this Y*) are
constant/exogenous.
Factor prices are fully
adjusted/endogenous.
Technology and factor
supplies (and thus Y*) are
changing.
What
Happens
Real GDP (Y) is
determined by aggregate
demand and aggregate
supply.
Factor prices adjust to
output gaps; real GDP
eventually returns to Y*.
Potential GDP (Y*) grows
over the long run.
Why We
Study This
State
To shows the effects of
AD and AS on real GDP.
To see how output gaps
cause factor prices to
change and why real GDP
tends to return to Y*.
To understand the nature of
long-run economic growth.
Key Points
• The boom that is associated with an inflationary gap generates a set of conditions – high
profits for firms and an excess demand for labour – that tends to cause wages (and other
factor prices) to rise.
• The slump associated with a recessionary gap generates a set of conditions – low profits
for firms and an excess supply of labour – that tends to cause wages (and other factor
prices) to fall.
• Both upward and downward adjustments to wages and unit costs do occur, but there are
differences in the speed at which they typically operate. Booms can cause wages to rise
rapidly; recessions usually cause wages to fall only slowly.
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Document Summary
Chapter 24: from the short run to the long run. Phillips curve originally, a relationship between the unemployment rate and the rate of change of nominal wages. Now often drawn as the relationship between gdp and the rate of change of nominal wages. Elements of the tax-and-transfer system that reduce the responsiveness of real gdp to changes in autonomous expenditure. The period of time between perceiving the problem and reaching a decision on what to do about it. Execution lag the time that it takes to put policies in place after a decision has been made. The attempt to maintain output as its potential level by means of frequent changes in fiscal policy or monetary policy. The use of macroeconomic policy to stabilize the economy such that large deviations from potential output do not persist for extended periods of time. Real gdp (y) is determined by aggregate demand and aggregate supply. Technology and factor supplies (and this y*) are constant/exogenous.
