Week 8 - The Short vs the Long Run

Question 1

What is an Output gap

Answer 1

The deviation of output from its long run trend (potential)

Question 2

What are some reasons to support the theory of Sticky Wages (x5)

Answer 2

1. Firms are reluctant to hire/fire employees if demand shock is temporary
2. Hiring new employees is costly
3. Firing involves redundancy/severance payments
4. Employees face costs to switch jobs
5. Work contracts limit firms’ ability to adjust hours/wages with changing market conditions

Question 3

When is Output affected in the SR

Answer 3

when actual inflation doesn’t equal expected inflation

actual inflation > expected inflation - output prices grow faster than wages

actual inflation < expected inflation - output prices grow slower than wages

firms increase output - positive output gap
firms decrease output - negative output gap

Question 4

How does labour market clearing depend on Time Frame

Answer 4

Short-run (months):
- Labour supply fluctuations mainly through hours worked, not employment
- Employees asked to work more/fewer hours
- Wages unlikely to change

Medium-run (6 months to 2 years):
- Firms adjust permanent workforce
- Employment contracts renegotiated
- Pressure on wages

Long-run (> 2 years):
- All contracts renegotiated
- Wages fully adjust to new labour demand