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Year 2 - Macro > T2 Topic 1 > Flashcards

T2 Topic 1 Flashcards

1
Q

See

A

intro ‘last term’

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2
Q

Why is a horizontal SRAS curve rarely realistic?

A

Because it implies in the SR firms can hire as much additional labour as they want without affecting the equilibrium wage; this is rarely the case (maybe in deep recession if a glut of workers)

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3
Q

What are frictions?

A

They are non-extremities; they allow us to model the new SRAS curve

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4
Q

What is the sticky price model concept?

A

Idea is that a portion of prices are fixed, and the remainder are flexible

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5
Q

What is the imperfect information idea?

A

That the general price level is not perfectly observed

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6
Q

What is the slope of the SRAS curve?

A

1/a

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7
Q

3 factors the GPL depends on and how it depends on them?

A

Expected future GPL (+)
Current level of output (+)
Natural level of output (-)

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8
Q

What is the key friction in the sticky price model (SPM)?

A

That firms do not immediately adjust their prices following a change in AD

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9
Q

Why in SPM don’t firms immediately adjust their prices following a change in AD? (3)

A

1) LT agreements/contracts with customers
2) ‘Menu costs’
3) Sticky wages; labour is an important FofP, difficult to decrease wages tf difficult to reduce prices

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10
Q

Evaluative point on menu costs being a reason for sticky prices?

A

Less relevant recently since as online shopping increases it is much easier to change prices

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11
Q

Explain how an individual firm would set prices according to p=P+a(Y-Y)bar))?

A

Increase in P causes an increase in costs
Higher AD causes increase in demand for their product

Tf ideally firm would set price p dependent on these two factors if they could continuously adjust p

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12
Q

How do firms with flexible prices set prices?

A

According to the equation for ‘desired prices’

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13
Q

How do firms with sticky prices set prices? What is the equation for this and how is it simplified?

A

In ADVANCE
p=EP+a(EY-EY)bar))
assume EY=EY(bar)
tf p=EP

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14
Q

Explain the weighted average of prices set by firms equations’ interpretation in the model?

A

1) Price increases with expected price (P=EP bit of eqn.)

2) Price increases with Y ((P=((1-s)/s)a(Y-Y(bar)) bit)

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15
Q

Explain why higher expected prices lead to higher actual prices?

A

Higher expected future prices imply higher expected future costs tf firms with sticky prices set higher prices today. Since p depends positively on P, firms with flexible prices will also increase their prices

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16
Q

Explain why prices increase with Y? Explain how a and s affect this price increase?

A

This refers to firms with flexible prices only, who increase prices when demand increases

If a is higher, then Y will have a larger effect on P
If s is higher, Y will have a smaller effect on P
(SEE DIAGRAM NOTES)

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17
Q

What does rearranging the weighted average of prices set by firms into a Y=… form tell us?

A

That the deviation of output from its natural level depends positively on the deviation of the price level from its expected level (and positively on s)

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18
Q

Explain the key friction for the imperfect information model (IIM)?

A

There are many goods so suppliers are unable to perfectly observe all prices at all times

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19
Q

3 assumptions for the imperfect information model?

A
  • prices are fully flexible
  • each supplier produces a single good and consumes goods from other suppliers
  • They each know the price of the good they produce but it’s too costly to monitor the prices of all other goods
20
Q

Explain the suppliers problem for the imperfect information model?

A

Suppliers choose how much to produce based on relative prices; when Pi/P is high suppliers are motivated to supply more goods
BUT supplier i only observes P imperfectly (Pi is price of own product, P is price of all goods)

21
Q

Explain the suppliers problem for the imperfect information model example?

A

If P increases by x%, but supplier i only observes an increase in Pi by x% they may increase output even though the relative price of their good hasn’t risen

22
Q

How do suppliers try to solve their problem?

A

They use an EP value

Tf if P is expected to rise x% and their good rises x% they wont increase output

23
Q

Explain the ‘all suppliers imperfect information model’ equation Y=Y(bar)+a(P-EP)? (2)

A

Output deviates from natural level when P deviates from EP

If P>EP, suppliers mistakenly interpret a rise in own price as a rise in relative prices tf they increase production (extent to which they respond depends on a)

24
Q

Explain the implication of the IIM model for countries with highly unstable AD?

A

P will also fluctuate lots, suppliers should realise that unexpected change in own price is unlikely to signal a change in relative prices tf Y should not respond much to P/=EP tf:
a should be small and SRAS steeper!

25
Q

Explain the implication of the IIM model for countries with stable AD?

A

Using reasoning on other card:

a will be large, SRAS will be flatter

26
Q

How does a change in EP affect SRAS curve?

A

Since SRAS curve is defined for a GIVEN EP:
If EP increases it shifts left
If EP decreases it shifts right
(SEE DIAGRAM NOTES)

27
Q

Explain the mechanism for going from A->C on diagram in notes, and draw diagram?

A

A->B: P>EP

B->C: EP eventually catches up with reality, tf SRAS shifts left

28
Q

Modern form Phillips Curve: What does inflation depend on? (3)

A

1) Expected inflation
2) Cyclical unemployment
3) Supply shocks (eg. oil prices)

29
Q

Prove the equation for the modern Phillips curve?

A

NOW (see notes)

30
Q

Explain demand pull inflation?

A

When a decline in cyclical unemployment (u-u(n)), places upward pressure on the rate of inflation (inc. D for workers -> inc. wages -> inc. prices)

31
Q

Explain cost push inflation?

A

v>0 for an adverse shock (eg. inc. oil prices

32
Q

See his slides

A

New vs Old Phillips curve

33
Q

Explain the theoretical implication of the modern Phillips curve? (“)

A

The classical dichotomy breaks down in the short run, tf real variables DO depend on nominal variables:

1) UWS SRAS: output depends on unexpected changes in the price level
2) Phillips curve: unemployment depends on unexpected changes in the rate of inflation

34
Q

Draw diagram showing PC, and what does it mean?

A

See notes

It presents policymakers with a ‘menu’ of inflation-unemployment combinations

35
Q

What does -beta measure?

A

The slope of the PC; ie. the tradeoff between inflation and unemployment

36
Q

What is the sacrifice ratio? Explain it?

A

The annual percentage of GDP required to bring inflation down by one percentage point
Why? if gov. wants to reduce inflation, this requires higher unemployment for a period of time tf lower output

37
Q

Typical estimate for SR?

A

5%

38
Q

Explain how different Phillips curves are different wrt the tradeoff?

A

Each PC is conditional upon a certain level of expected inflation. As expected inflation increases for a given inflation level, the tradeoff of low inflation for high U becomes less favourable (see notes)

39
Q

Explain the long run case for output?

A

When π=Eπ and v=0: u=u(n)

ie. output at natural level since LRAS is vertical and tf classical dichotomy is restored

40
Q

What did the study on US data show about PCs?

A

That there isn’t just one Phillips curve, but many, for different periods of expected inflation (see slides)

41
Q

What is hysteresis?

A

The concept that historical variables may affect current variables (eg. time lag)

42
Q

Our model assumes changes to the constant natural level of Y and U being temporary and in the SR. Explain the disagreement with this?

A

(Eg. Ball 2008) believe increased unemployment in short run can lead to increased unemployment in LR leaving permanent ‘scars’; for example in LR unemployment workers can lose their employability tf -> increase u(n) (see US data in slides)

43
Q

SEE

A

note on expectations, and summary/conclusions

44
Q

In the case of cost-push inflation, the PC suggests that…?

A

Both the inflation rate and the unemployment rate rise (shifts PC to the right due to supply shock)

45
Q

According to the sticky-price model, the greater the proportion of firms that have sticky prices the __________ the __________ in output in response to an unexpected rise in prices:

A

greater; increase

46
Q

According to the imperfect-information model, when the general price level (P) falls but the producer did not expect it to fall, the producer:

A

decreases production

Year 2 - Macro (14 decks)

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