Chapter 9 Flashcards
Profit effect
If P increases while input prices are fixed, producers now make more profit and then encourage producers to produce more increasing production
Misperception effect
if prices increase producers could be fooled that there is an increase in the relative price of their product so they will produce more of it.
Aggregate Supply
Any change in P causes a movement along SRAs
Short Run
shows the positive relation between P & Y when all input prices are fixed, there are contracts that fix input prices in short run
Long run
Vertical perfectly inelastic and shows the relationship between P & Y when input prices are not fixed.
Potential output (YNR)
what we could produce if we use all our resources.
Both SRA’s & LRA’s will shift right (Increase) if
Q resources increase, (land, capital, labor, technology, increased productivity)
A decrease in Trade barriers (tariffs), Government waste and inefficiency and Government Regulations
Negative supply shocks (temporary shifts) in SRAs
temporary increase in Pinputs (wages P(oil)) and temporary shock “events” like war, disaster, etc.
How to close a Recessionary gap “Invisible hand”
during recession, there Is excess supply of labor “a lot of unemployed workers” so wages & other input prices decrease. The cost of production lowers and the profits to produce will increase. This encourages them to produce more SRAs to increase (shift right) and then recessionary gap is closed at a lower price.
How to close the Inflationary Gap (boom) “invisible hand”
during a boom there is an excess demand on labor and other inputs so wages and other input prices increase. This causes cost of production to increase and profits to producers will diminish. This pushes them to supply less SRAs to decrease (shift left) and the inflationary gap is closed at a higher price
The speed of the self correction mechanisms is slow due to:
1) resistance from labor unions who refuse wage cuts
2) Minimum wage laws that prevent wages from decreasing below a certain level
3) Input prices including wages are sometime fixed by contracts
4) Efficiency waste, at times the employers pay higher wages to workers to encourage them and make them more productive and they may not want to decrease it
5) Menu cost, cost to sellers to change the price list
Inflation
increase to price level (CPI and GDP deflator)
Inflation Gap
The Boom, what we actually produce > potential output
Demand Pull inflation
Positive AD shock, AD increases causing price level to rise.
Cost Push inflation
Adverse supply shock, decrease in SRAs causes price level to rise due to increase to P(inputs)
