Notes for Macroeconomics 2

CLC
Dr. Luu Minh Duc
S2/2021
Course Objectives
• Knowledge of key concepts in macroeconomics such as:
• GDP, GNP, GDP deflator, CPI, real interest rates, unemployment, GDP growth,
saving, investment, aggregate demand and supply, fiscal and monetary policies
• Skills of searching for macroeconomic information; initially measuring
and analysing the macroeconomic data;
• Formulation of thinking about macroeconomic issues as a semi-
economist;
• Learning attitude
W1: 27 Feb

THE POLICY AND PRACTICE OF MACROECONOMICS

THE STARTING POINTS OF GOVT’S POLICIES?
PRACTICE: How is the economy?
- Instabilities (short-term): short-term increase of unemployment rate,
inflation, budget deficits ---- public debts (deficit: over 3-5% or debt: 50-
60% GDP), trade deficit ---- exchange rates ---- interest rates; GDP = C + I +
G + NX; external shocks/business cycles (demand, supply)
- Growth (long-term): reviving growth when it tends to be slowing-down,
economic recession, to achieve full employment, sustain high growth;
- Long-term GDP growth depends on:
- Conditions: stabilities, business environment/investment climate, trade
agreements;
- Resources: human capital (quantity, skills); natural resources; technologies
(knowledge, sciences); infrastructure (public facilities); investment (access to
capital)
So, the Govt needs to STABILISE the economy and REVIVE or
SUSTAIN the economic growth
POLICY: How can the Government intervene into the market/ economy?
- Fiscal policy: tax, tariff, subsidies, prices of essential goods and services
- Government’s income ---- fiscal policy
- Consumption: reducing the tax to boost consumption
- Firms & individuals: increasing subsidies to enhance investment and consumption
- Government’s consumption and public investment
- Monetary policy: to control the money supply, by the central bank, through the interest
rates/open markets/reserve ratio/discount rates; to control/boost inflation
- Interest rates --- loanable funds (financial markets) --- money supply; in other words, ‘prices’ of
credit/capital.
- Bonds: assets; bonds premium interest;
- Opportunity costs: bonds interest/ bank deposit interest/ have to pay for the borrowing interest
- Other policies: building/improving institutions
- Legal framework: market dispute settlement to protect firms, investors, consumers: by making
laws and regulations, safe and favourable business environment
- Education policy, health-care policy, technology-sciences policy, innovation
W2: 6 Mar
MEASURING ECONOMIC DATA
• GDP: the market value of all final products and services produced in a
country within a certain period of time
• Total production (value added) = Total expenditure (final goods and
services) = Total income (wages, rents, profits, interest)
• Capital goods: machine, equipment – investment, not intermediate goods
--- depreciation
• Investment: fixed investment, inventory investment, residential
investment
• Purchasing stocks or bonds is not investment, but saving
• GDP: newly produced, legal, montarised
• GDP: Domestic, emphasis on location; GNP/GNI: National, on people
- A Steel maker sells 3000$ of steel for car maker; 1000$ for machine maker
- Machine maker sells machines valued of 2000$ to the car maker
- Tires maker sells 500$ to the car maker
- Car maker sells 5000$ cars to households

Goods & Sellers Buyers Value of Added values Expenditure Income

services transactions for final
goods
Steel Steel maker Car maker 3000 3000 3000
Steel Steel maker Machine 1000 1000 1000
maker
Machine Machine Car maker 2000 1000 2000 I 1000
maker
Tires Tires maker Car maker 500 500 500
Cars Car maker Households 5000 1500 5000 C 1500
Total value of 11500
transations
GDP 7000 7000 7000
Homework
• What happens to GDP?
• If the car maker built a factory valued at 1000 that year? Which column should you put it in the
table?
• GDP increases 1000; it is added to the Expenditure of Capital good
• If the tires maker imported all of its 500 worth of tires?
• GDP reduces 500
• If the car maker produced 8000 in total and sold 5000 in the domestic market and export 3000?
• GDP rises 3000
• With all the above conditions, can you re-write the GDP from the expenditure approach,
ie. compositions C + I + G + NX, if the Government bought 2500 value of the cars?
• Y = 2500 + 3000 + 2500 + 2500 = 10500
• If wages take account of 70% of the income, how much are they, given the above
conditions?
• W = 70% * 10500 = 7350
• If the domestic households bought 1000 worth of imported car, reduced 500 from the
car maker?
• Y = (2500+1000-500) + 3000 + 2500 + (3000 – 500 – 1000) = 10000 (if there is no inventory
investment)
• Y = (2500+1000-500) + (3000 + 500) + 2500 + (3000 – 500 – 1000) = 10500 (If there is inventory
investment)
• Policies: Import-substitution policy; Export-oriented policy
W3:13 Mar
Discussion: How GDP is more or less?
• What are the disadvantages and advantages of the GDP calculation?
• Housework, informal sector are not taken into account;
• Externalities is not calculated, balanced;
• Equality is an issue, not addressed by GDP
• Black market, illegal economic activities are not included in GDP

• Advantage of GDP: most measurable and comparable tool among countries

• What values should be deducted from and/or added to the GDP?

• Negative externalities: environmental pollution; negative impact on the society and health,
Pigauvian tax, climate change
• Positive externalities: life expectancy, education engagement, career development,
knowledge and skills, human resources, economies of scale
Goods Sellers Buyers Values of Added Expenditure Income EX - IM
transaction values for final
goods
Steel Steel maker Car maker 3000 3000 3000

Steel Steel maker Machine 1000 1000 1000

maker
Machine Machine Car maker 2000 1000 2000 I 1000
maker
Factory Builder Car maker 1000 1000 1000 I 1000
Tires Tires maker Car maker 500 0 0 0 -500 IM

Cars Car maker Households 2500 750 (shared 2500 C 750

costs)
Cars Car maker Households 3000 3000 0 3000 3000 EX
abroad
Cars Car maker Government 2500 750 (share 2500 G 750
costs)
Total value of 15500
transactions
GDP 10500 8000 10500 2500
W4: 20 Mar
Consolidation and doing practice tests
• GDP: measured by 3 approaches
• Production approach:
• Final goods and services vs. intermediate goods and services
• Capital goods and inventory investments: Investment
• Newly produced
• Domestic vs. residents (GNP)
• Expenditure approach: C + I + G + NX
• Page 26 in Mishkin’s textbook: footnote 2 about how to treat Import in calculation of GDP
• Income approach:
• Page 28; 29
• GDP + Net Factor Income = GNP
• GNP – Depreciation = National Income
• GNP = Private diposable income + Net Government income
• Nominal vs. Real GDP
• Nominal GDP = quantity (current year) * price (current year)
• Real GDP = quantity (current year) * price (base year)
• Price indexes:
• GDP deflator = Nominal GDP/ Real GDP * 100
• Real GDP = Nominal GDP/ GDP deflator * 100
• CPI = cost of the consuming basket in current year/ cost of the consuming
basket in base year * 100
• Note: the base year is adjusted periodically to reflect price changes more
accurately.
• Inflation rate:
• Page 33; 34
• Inflation rate is the percentage change in the CPI/GDP deflator from the
previous year * 100%
• Growth rate of Norminal GDP = Inflation rate + Growth rate of Real GDP
• Unemployment:
• Page 36
• Adult population = Civilian labour force + Not in the labour force
• Labour force = Employed + Unemployed
• Unemployment rate = Number of Unemployed/ Labour force
• Labour force participation = Labour force/ Adult population

• Nominal vs. Real Interest rates:

• Page 39
• Nominal Interest rate = Real interest rate + Inflation
• Real Interest rate = Nominal Interest rate – Inflation
• Note: answers to Question 27; 28; 29 in the Practice tests are D;D;A
respectively
W5. 27 Mar
Interest rate and Present value
Year 0 Year 1 Year 2

Interest rate = 10%

1$ loan at present 1.0 1.1 1.21

Present value of 1$ 1.0 0.91 0.83

Interest rate = 5%

1$ loan at present 1.0 1.05 1.10

Present value of 1$ 1.0 0.95 0.91

• Present value = Cash flow/ (1+ r)t

• Opportunity Cost of holding cash = (Nominal interest rate – Inflation) + Inflation = Nominal
interest rate
13
Practice:
Assuming an economy comprising only chicken and rice and
Year 2 is the base year, could you calculate the nominal and
real GDP of each year; GDP deflator, in this case equal to CPI;
the inflation; and GDP growth rate?
Rice Chicken GDP GDP Inflation GDP
Deflator growth
rate
Price Quantity Price Quantity Nominal Real
Year 1 2 120 4 80 560 636 88
Year 2 2.5 150 4.2 90 753 753 100 13.6% 18.39%
Year 3 2.8 170 4.5 95 903.5 824 109.6 9.6% 9.42%

Mini-Project: Searching and analysing macroeconomic data

W5-6. 3 Apr
Chapter 3. Aggregate production and productivity
• Y = F(K,L) = AKαL1-α
• A: Total Factor Productivity; Solow residual;
• A = Y/KαL1-α
• Labour Productivity: assume all citizens works, so income per capita is
equal to labour productivity
• y = Y/L = Akα
• It means labour productivity is influenced by k – capital per worker
• Yet, the empirical evidence shows that A is more important than k
(page 50)
• Reference:
• https://blogs.worldbank.org/opendata/new-world-bank-country-classifications
-income-level-2020-2021#:~:text=The%20World%20Bank%20assigns%20the,i.e.
%202019%20in%20this%20case
).
• Cobb-Douglas Production Function
• Constant returns to scale
• Diminishing returns to scale
• MPK: as the capital stock increases the marginal product of capital declines
• MPL: as the capital stock increase the marginal product of labour declines
• Supply shocks:
• Causing the aggregate production function to shift downward (MPK, MPL fall); or
upward (MPK, MPL rise)
• Demand for capital and labour:
• Nominal economic profits = P X F(K,L) – RK – WL
• Real economic profits = F(K,L) – rcK (retal price of capital) – wL (real wage rate)
• Firms demand capital and labour with the aim of Profit maximization:
• MPK = rc ; MPL = w
• Excess supply in labour/ capital markets: w/r c fall
• Excess demand in labour/capital markets: w/r c rise (page 59)
• National income = Y = rcK + wL = real capital income + real labour income
• Capital income share = rcK/Y = α
• Labour income share = wL/Y = 1- α
W6. 3 Apr
Chapter 4. Saving and Investment in Closed and Open economy
• Saving: (page 68)
• Yd (disposable income) = Y – T (net tax)
• Sp (private saving) = Y – T – C
• Sg (government saving) = T – G
• S (national saving ) = Sp + Sg = Y – C – G
• Open economy: (page 71)
• Y = C + I + G + NX
• S = (C + I + G + NX) – C – G = I + NX
• S – I = NX
• Net capital out flow = Net export (trade balance)
• (Sp + Sg) = NX + I
• Sp – I = NX – Sg (net outflow must be balanced either by net export or budget deficit)
• Closed economy: (page 76)
• Y=C+I+G
• I=Y–C–G
• S=I
W7. 10 Apr
Chapter 5. Money and inflation
• Velocity of money (V):
P Y
V
M
• Equation of exchange: nominal income to M2 and velocity

M  Vnominal
• Quantity theory of money:  P  Y income is determined solely by movements
in the quantity of money

P Y
• Neutrality of money: in the long run, changes  Mquantity
in the  V of money lead to
proportional changes in the price level

M V
P
• Inflation rate: Y

  %P  %M  %Y

W8. 17 Apr: Mid-term exam
Chapter 6. The Sources of Growth and the Solow
model
• Production function: income per-worker

• Investment = saving rate x income

it  syt

• Investment function relates per capita

investment to per capita capital 0.3
stock
it  sAkt
• Capital accumulation equation: kt = it   kt
Change in capital = Investment  Depreciation
stock per worker per worker per worker

• Steady state occurs when kt  0

sAkt0.3  kt

Investment = Depreciation

• Pls. remember the “bathtube model” of the steady state!

• Investment: inflows; Depreciation: outflows; Capital stock: rises/reduces to the steady state

• For output per worker, add consumption:

Output per worker: adding consumption
Response to a rise in saving or productivity
Response to a rise in population growth rate
W9. 24 Apr
Chapter 7. Drivers of Growth
• Technology
• Policy
• Institutions
Chapter 8. Business Cycles
• Fluctuations on aggregate economic activity
– Long-run trend: potential output (YP)
– Short-run deviations from trend: output gap (Y–YP)
• Co-movement of economic variables:
– Procyclical
– Countercylcial
– Acyclical
• Timing of economic variables:
– Leading variable
– Lagging variable
– Coincident variable
• Leading indicators:
– Real GDP
– Real consumer spending and investment
– Unemployment
– Inflation
– Financial variables: stock and bond prices
– The spread: difference between interest rates of the
• The Short-run vs. the Long-run
in Macroeconomics
• Classical economists: economies
move quickly to their long-run
equilibriums
• Prices and wages are completely
flexible and adjust to their long-run
equilibriums of supply/demand
• Keynes: primary of
macroeconomists should be the
short-run; government policies
should stabilize economic
fluctuations (business cycles)
• Sticky prices: slowly responding to
supply/demand
W.10 8 May
Chapter 9: The IS Curve
• Before examining the IS curve which describes the relationship between
interest rate and aggregate output when the goods market is in equilibrium,
• I think you should review the basic concepts about the Aggregate
Demand/Aggregate Supply – the overall equilibrium of the economy in the
short run;
• At a certain price level (sticky price, if according to Keynes), the Aggregate
Expenditure, which describes the relationship between output, income and
expenditure (three approaches of the GDP), will help us to understand the
formulation of Aggregate Demand in details.
• So, I copy hereby a series of slides brought from the Macroeconomics 1, as
follows:
 Chương 6: AD – AS
Mức giá,
P
Khái niệm: Tổng cầu (ký hiệu là
AD) là tổng khối lượng hàng hóa
P0
và dịch vụ được sản xuất trong
nước mà các tác nhân trong nền P1

kinh tế muốn mua và có khả năng AD

mua tại mỗi mức giá chung, trong

điều kiện thu nhập và các biến số Q0 Q1 Sản lượng, Q

kinh tế khác không đổi

29
Tổng cầu: AD
Trong nền kinh tế mở:

AD = C + I + G + EX – IM
Các yếu tố ảnh hưởng đến tổng cầu của nền kinh tế:
1. Mức giá chung
2. Lãi suất
3. Thu nhập có thể sử dụng (khả dụng)
4. Tỷ giá hối đoái
5. Chính sách của Chính phủ
6. Kỳ vọng
7. Dân số
30
Tổng cung – AS
 Khái niệm: Tổng cung (ký hiệu là AS) là tổng
khối lượng hàng hóa và dịch vụ mà các doanh P ASLR ASSR
nghiệp trong nền kinh tế muốn cung ứng và
có khả năng cung ứng trong nước tại mỗi mức
giá chung, trong điều kiện chi phí sản xuất và
các biến số kinh tế khác không đổi

 Đường tổng cung dài hạn (ASLR): liên kết

mức giá với mức sản xuất xét trong khoảng Y* Q
thời gian đủ dài để các nhân tố khác với giá
hoàn toàn linh hoạt.

 Đường tổng cung ngắn hạn (ASSR): liên kết

mức giá với mức sản xuất với giả thiết các
nhân tố khác với giá không thay đổi. 31
Sản lượng tiềm năng: là mức sản lượng mà nền kinh tế có thể đạt được trong điều
kiện toàn dụng nhân công mà không gây nên lạm phát

 Các yếu tố làm thay đổi mức sản lượng tiềm năng của nền kinh tế:
- Lao động
- Tư bản (tư bản hữu hình, vốn nhân lực):
- Tài nguyên thiên nhiên
- Trình độ công nghệ

 Các yếu tố ảnh hưởng đến AS ngắn hạn:

- Số lượng nguồn lực
- Mức giá chung
- Chi phí sản xuất
- Chính sách của Chính phủ: thuế TNDN, thuế đối với đầu vào SX
- Kỳ vọng của các nhà SX
- Số lượng các nhà SX 32
 Sản lượng cân bằng
Mức giá, P
AS
P2
E0
P0

P1

AD

Y0 Sản lượng, Y

Tại E0: cả người mua và người bán đều thỏa mãn  thị trường ổn
định và không có áp lực điều chỉnh 33
Nhớ lại chương trước:

• Mô hình đường tổng cung và đường tổng cầu

khi nềnP kinh tế ở ASxa mức
LR AS
sản lượng tiềm
năng.
SR

AD

Y Y* Q
7.1. Mô hình giao điểm Keynes

1. Giả thiết: P

Nền kinh tế còn nhiều AD1

AD0
nguồn lực chưa sử
dụng  Đường tổng
E0 E1
P0
cung là đường nằm AS0

ngang  Mức giá

không thay đổi  tổng
cầu quyết định sản Y0 Y1 Y

lượng của nền kinh tế

7.1. Mô hình giao điểm Keynes

2. Đường tổng chi tiêu:

Khái niệm: Tổng chi tiêu (Aggregate

Expenditure – AE) là tổng khối lượng hàng hóa
và dịch vụ trong nước mà các tác nhân trong
nền kinh tế dự kiến chi tiêu tương ứng với mỗi
mức thu nhập trong điều kiện mức giá chung
và các yếu tố khác không đổi.
7.1.2. Đường tổng chi tiêu và sản lượng
cân bằng
Đường tổng chi tiêu (AE):
Tổng chi tiêu, AE
- Hệ trục Y – AE AE

- Y  AE  đường AE dốc lên trên

- Khi Y = 0  AE > 0  đường AE cắt
trục tung tại một điểm lớn hơn 0. AE o:
chi tiêu tự định AE0

- AE = C + I + G + EX – IM
- Đường 450: AE = Y Thu nhập, Y
Hàm tiêu dùng
•  C
𝐂=
  𝐂´ + 𝐌𝐏𝐂 . 𝐘 𝐝
(7.4)
• MPC: xu hướng tiêu dùng cận
C* E
biên. Cho biết khi Yd tăng 1
đơn vị thì tiêu dùng tăng bao
nhiêu đơn vị
• Yd (= Y – T): thu nhập khả
dụng (thu nhập sau khi đã nộp 450
thuế và nhận các khoản trợ Y* Y

cấp nếu có).

 Hàm tiết kiệm và số nhân tiết kiệm
•Hàm
  tiết kiệm và đồ thị: C
 Hàm tiết kiệm C=
 
E
S = Yd – C (7.6)
 S = Yd – ()
S=- 450
0
S=- (7.7) Y

S
S

0
Y

- 

39
40
Sản lượng cân bằng trong nền kinh tế giản đơn
•Nền
  kinh tế đạt trạng thái cân bằng khi tổng AE
E1 C + I +
AE1  
chi tiêu dự kiến bằng tổng thu nhập dự kiến:
AE = Y; C+I
AE =
Y = AE0
E0
• Nếu đặt m = thì m được gọi là số nhân chi
tiêu của nền kinh tế giản đơn.
• Ảnh hưởng của sự gia tăng đầu tư đến sản
lượng của nền kinh tế, giải thích tại sao sản
lượng được khuếch đại? Ví dụ như slide
trên.
450

Y0 Y1 Y

41
Nền kinh tế có sự tham gia của Chính phủ
 Hàm tổng chi tiêu có sự tham gia của A
E Đường AE
Chính phủ: Yd = Y - T trước thuế
AE E0
0 Đường AE
 Hàm thuế
AE1 sau thuế
• Trường hợp tổng quát: E1
T = f(Y) =
Trong đó: 450
Y1 Y0 Y
t : thuế suất biên
 Trường hợp 1: T = AE
AE1 E1 C+I+
 Trường hợp 2: T = tY GC+I

• 
• Xét 2 trường hợp:
AE0 E0

 2.  Yd = Y – tY = Y(1-t)
•  450
Y0 Y1 Y
42
Sản lượng cân bằng trong nền kinh tế mở
AE AE=C+I+G +EX-IM
Tổng chi tiêu trong nền kinh tế mở: AE=C+I+G
AE = C + I + G + EX – IM AE=C+I
C
 
 • IM: Người dân trong nước dự kiến chi tiêu
nhiều hay ít vào hàng nhập khẩu từ nước
ngoài có phụ thuộc trực tiếp vào khả năng
chi trả (thu nhập) của họ không?
 IM là một hàm số của Y:
IM = + MPM x Y
Trong đó: MPM là xu hướng nhập khẩu cận
biên Y0 Y1 Y2 Y3 Y

• 
• 
• = MPC: 0,9; 1-t = 1-0,2 = 0,8; MPC’ = 0,72; MPC’’ = 0,72 – 0,02 = 0,7
1-0,7 (chi tiêu cho hàng trong nước) = 0,3 (0,2 thuế; 0,08 tiết kiệm; 0,02 nhập khẩu)

43
Cách tiếp cận thu nhập – chi tiêu; tổng cầu – tổng cung

 P2 > P1
AE E1 AE(P1)

AE(P2)
E2

450
Y2 Y1 Y
P

E2
P2
E1
P1 AD

Y2 Y1 Y
44
Chapter 9. The IS curve
• Keynes viewed aggregate demand as planned expenditure
• Ype = C + I + G + NX = Y (when the goods market is in equilibrium)
• Because consumption, investment, net exports are negatively related
to the real interest rate
 Saving – Investment diagram vs. the IS curve
• The goods market equilibrium of the IS curve is equivalent to the
equilibrium at which desired investment, I, equals desired saving, S
What factors shift the IS curve?
Fiscal policy
W11. 15 May
Chapter 10. Monetary policy r  r  
and aggregate demand where
r  autonomous component of r
• The monetary policy (MP)   responsiveness of r to inflation
curve shows the positive
relationship between real
interest rates and inflation
• To stabilize inflation, central
banks must raise nominal
interest rates by more than any
rise in expected inflation, so
that r rises rwhen
 i  inflation
e rises
(Taylor principle)
Shifts in the monetary policy curve
MP curve – IS curve – AD curve
The AD curve is derived from the MP curve and IS curve
Fiscal policy and AD curve
1 cdx
Y  [C  I  G  NX  mpc  T ]    (r  )
1  mpc 1  mpc
• Any factor that shifts the IS curve shifts the aggregate demand curve in the same direction
Monetary Policy and the AD

• Shifts in the MP curve

– An autonomous tightening of monetary policy, that is a rise in real interest rate at any given
inflation rate, shifts the aggregate demand curve to the left
– Similarly, an autonomous easing of monetary policy shifts the aggregate demand curve to the right
Real money balances
• Keynes developed the liquidity
preference theory or theory of M d / P  L(i, Y )
money demand (how much 
money people want to hold in where
real terms)
i = nominal interest rate
• Liquidity preference
Y = nominal income
framework: equilibrium
interest rates by equating the
supply and demand for money
• Interest rate: is the cost of
holding money, so negatively
related
• Income (Y): means more
transaction and assets, so
positively related to Md
Demand curve and Supply curve for money
• Demand curve slopes downward
as the interest rate is negatively
related to the money demand
• Supply curve for money is vertical
because the money supply is
determined by the Central Bank
according to its particular aims:
controlling inflation or boosting
the economic growth
• A shift in each of the two curves
occurs when there are factors
besides the interest rate
Responses to Shifts in the Demand Curve and the
Supply Curve
W12. 22 May
Chapter 11. Aggregate Supply
and the Phillips Curve
• The Phillips curve shows the
negative relationship between
unemployment and inflation
• It is correct in the short term
that there is a tradeoff
between the inflation and
unemployment
• Yet, in the long term, when the
wages and prices are flexible,
the economy would reach the
natural rate of unemployment
The Friedman-Feld Phillips Curve analysis
• Expectations-augmented   e  (U  Un )
where
Phillips curve: suppose the   inflation
unemployment rate is below e  expected inflation
  sensitivity of  to unemployment gap (U  Un )
the natural rate, then:
U  unemployment
• The economy will first move
Un  natural rate of unemployment
leftward along the Phillips curve
with rising inflation
• In the long run, expected inflation
must gravitate to actual inflation,
so that the Phillips curve shifts
upward until expected inflation
equals the new inflation rate
• The line connecting the shifting
expectations-augmented Phillips
curve is the long-run Phillips curve
(LRPC)
Deriving the Aggregate Supply curve
• A rise in prices, e.g. due to a cost-
push shock is added by economists   e  (U  Un )  
as p   1  (U  Un )  
• higher wages for workers than
productivity gains or     1  (U  Un )  
• Inflation expectation:
• formed by looking at inflation in the
previous period
• Replacing the Unemployment gap
with the Output gap
• Unemployment gap and Output gap
has a negative relationship: Okun’s
law U  U n   0.5  (Y  Y P
)
The Aggregate Supply Curve
• AS curve
• connects the total quantity of output
that firms are willing to produce and
the inflation rates
• Long-run AS curve is vertical at the
potential output
• Short-run AS curve: substituting in
the Okun’s law, with adaptive
expectations of the inflation, and
=0.5   e  (Y  Y P )  
assuming Inflation  Expected    Output  Price
Inflation Gap Shock

   1  (Y  Y P )  
• For
 example:
1
2%, =0, =1.5, and Y P
=

$10 trillion   2  1.5  (Y  10)

The Aggregate Supply Curve
• In the short-run, the AS curve is
the very Phillips curve, with a
positive relationship between
inflation and output gap.
• In the long-run, when the wages
and prices are flexible, it becomes
vertical as the LRAS, which is only
affected by changes in: Capital,
Labour, Technology.
• The short-run AS curve is shifted
by:
• Expected inflation
• Price shock
• Persistent output gap
Chapter 12. The Aggregate Demand and Supply Model
• AD curve is derived from the IS and MP
curves; AS curve is derived from the Phillips
curve
• General equilibrium occurs when all
markets are simultaneously in equilibrium
at the point where the AD and the AS
curves intersects with each other
• Correspondingly with the long-run and
short-run AS curves, the two equilibriums
exist
• If the output differs from its potential level,
the short-run equilibrium will move over
time as the wages and prices adjusted to
the expected inflation
• It is called the self-correcting mechanism of
the economy to restore its full employment
Aggregate demand shocks
• Demand shocks are factors that
cause the AD curve to shift:
• Positive demand shocks make a
rightward shift of the AD curve initially,
but in the long-run only the inflation
rises
• Negative demand shocks move the AD
curve to the left, so the unemployment
rises, inflation falls; the AS also shifts
downward until the potential output is
restore with lower inflation
• Vocker disinflation is an example that
the Central Bank made a negative
demand shock by tightening the
monetary policy, i.e. raising the interest
rate, to clamp down the inflation
Two types of Aggregate Supply shocks
• Temporary shocks that do not shift the
LRAS curve
• A negative shock causes the stagflation
(higher inflation, lower output), but in
the long-run, it will move back to the
equilibrium (if the demand curve is
unchanged); and vice versa for the
positive shock
• Permanent shocks that make the LRAS
curve shift
• A permanent negative shock shifts the
AS to the left, and causes a permanent
decline in output and rise in inflation;
and vice versa for the positive shock