Chapter 15 - Long run macroeconomic adjustments. After studying this chapter you will be able to understand: To apply the long-run AD-AS model, about the inflation-unemployment relationship, about the effects of taxation on aggregate supply.
Long Run Macroeconomic Adjustments Chapter 15 SLIDES PREPARED BY JUDITH SKUCE, GEORGIAN COLLEGE © 2002 McGraw-Hill Ryerson Ltd Macroeconomics, Chapter 15 In this chapter you will learn To apply the long-run AD-AS model About the inflation-unemployment relationship About the effects of taxation on aggregate supply © 2002 McGraw-Hill Ryerson Ltd Macroeconomics, Chapter 15 Chapter 15 Topics Applying the Long-Run AD-AS Model The Inflation-Unemployment Relationship Taxation & Aggregate Supply © 2002 McGraw-Hill Ryerson Ltd Macroeconomics, Chapter 15 Applying the Long-Run AD-AS Model Demand-pull inflation occurs when an increase in aggregate demand pulls up the price level © 2002 McGraw-Hill Ryerson Ltd Macroeconomics, Chapter 15 Demand-Pull Inflation Figure 15-1 Price Level AD1 AS1 The starting point is full employment GDP (Qf ) PL1 o Qf Real domestic output © 2002 McGraw-Hill Ryerson Ltd Macroeconomics, Chapter 15 Demand-Pull Inflation Figure 15-1 Price Level AD1 AS1 Something causes AD to increase… what are some possibilities? PL1 o Qf Real domestic output © 2002 McGraw-Hill Ryerson Ltd Macroeconomics, Chapter 15 Demand-Pull Inflation Figure 15-1 Price Level AD1 AD2 AS1 PL2 Higher demand leads to a higher price level, and higher output PL1 o Qf Q2 Real domestic output © 2002 McGraw-Hill Ryerson Ltd Macroeconomics, Chapter 15 Demand-Pull Inflation Figure 15-1 Price Level AD1 AD2 AS1 PL2 A higher price level (PL2 ) EVENTUALLY leads to higher nominal wages which causes PL1 o Qf Q2 Real domestic output © 2002 McGraw-Hill Ryerson Ltd Macroeconomics, Chapter 15 Demand-Pull Inflation Figure 15-1 Price Level AD1 AS2 AD2 AS1 PL3 PL2 A left shift of the short run AS curve PL1 o Qf Q2 Real domestic output © 2002 McGraw-Hill Ryerson Ltd Macroeconomics, Chapter 15 Demand-Pull Inflation in the short run, demand-pull inflation drives up prices and output in the long run, output is restored to Qf and only the price level is higher © 2002 McGraw-Hill Ryerson Ltd Macroeconomics, Chapter 15 10 The Long-Run Phillips Curve Annual rate of inflation (percent) Figure 15-7 PCLR 15 what about disinflation? suppose the economy is at a3 & AD declines PC3 12 a3 c3 3 Unemployment rate (per cent) © 2002 McGraw-Hill Ryerson Ltd Macroeconomics, Chapter 15 46 The Long-Run Phillips Curve Annual rate of inflation (percent) Figure 15-7 PCLR 15 firms & workers eventually adjust to lower 6% inflation PC3 12 PC2 a3 a2 c3 3 Unemployment rate (per cent) © 2002 McGraw-Hill Ryerson Ltd Macroeconomics, Chapter 15 47 The Long-Run Phillips Curve Annual rate of inflation (percent) Figure 15-7 PCLR 15 if AD falls further, the scenario will continue PC3 12 PC2 PC1 a3 a2 a1 c3 c2 Unemployment rate (per cent) © 2002 McGraw-Hill Ryerson Ltd Macroeconomics, Chapter 15 48 Chapter 15 Topics Applying the Long-Run AD-AS Model The Inflation-Unemployment Relationship Taxation & Aggregate Supply © 2002 McGraw-Hill Ryerson Ltd Macroeconomics, Chapter 15 49 Taxation & Aggregate Supply Government policies can impede or promote rightward shifts of AS © 2002 McGraw-Hill Ryerson Ltd Macroeconomics, Chapter 15 50 Supply-Side Economics Price Level AS1 PL1 PL2 AS2 unemployment & inflation are both reduced AD o Q1 Q2 Real domestic output © 2002 McGraw-Hill Ryerson Ltd Macroeconomics, Chapter 15 51 Taxation & Aggregate Supply Supply-siders argue that high marginal tax rates are impeding productivity growth Taxes & Incentives to Work Incentives to Save & Invest © 2002 McGraw-Hill Ryerson Ltd Macroeconomics, Chapter 15 52 The Laffer Curve It is possible that reductions in marginal tax rates will increase AS but leave tax revenues unchanged illustrated… © 2002 McGraw-Hill Ryerson Ltd Macroeconomics, Chapter 15 53 Laffer Curve Figure 15-8 100 Tax rate (percent) Shows impact of tax rates upon tax collections Tax revenue (dollars) © 2002 McGraw-Hill Ryerson Ltd Macroeconomics, Chapter 15 54 Laffer Curve Figure 15-8 100 Tax rate (percent) increase tax rates and tax revenues increase l Tax revenue (dollars) © 2002 McGraw-Hill Ryerson Ltd Macroeconomics, Chapter 15 55 Laffer Curve Figure 15-8 tax revenues increase at a decreasing rate as rates m rise further Tax rate (percent) 100 m l Tax revenue (dollars) © 2002 McGraw-Hill Ryerson Ltd Macroeconomics, Chapter 15 56 Laffer Curve Figure 15-8 100 Tax rate (percent) n m m l at some point, rates are so high that economic activity decreases, and cheating increases Tax revenue (dollars) © 2002 McGraw-Hill Ryerson Ltd Macroeconomics, Chapter 15 57 Laffer Curve Figure 15-8 100 Tax rate (percent) n m m l Tax revenue (dollars) © 2002 McGraw-Hill Ryerson Ltd Macroeconomics, Chapter 15 58 Criticisms of the Laffer Curve Taxes, Incentives and Time – substitution effect as well as income effect Inflation – demand side effects may be greater/quicker Position on Curve – where are we? © 2002 McGraw-Hill Ryerson Ltd Macroeconomics, Chapter 15 59 Chapter 15 Topics Applying the Long-Run AD-AS Model The Inflation-Unemployment Relationship Taxation & Aggregate Supply © 2002 McGraw-Hill Ryerson Ltd Macroeconomics, Chapter 15 60 ... Macroeconomics, Chapter 15 Chapter 15 Topics Applying the Long- Run AD-AS Model The Inflation-Unemployment Relationship Taxation & Aggregate Supply © 2002 McGraw-Hill Ryerson Ltd Macroeconomics, Chapter. .. full employment? probably a long time © 2002 McGraw-Hill Ryerson Ltd Macroeconomics, Chapter 15 22 Chapter 15 Topics Applying the Long- Run AD-AS Model The Inflation-Unemployment Relationship Taxation... loss of output © 2002 McGraw-Hill Ryerson Ltd Macroeconomics, Chapter 15 21 Recession & the Long- Run AD-AS Model how long would it take in the real world for price & wage adjustments to occur, to