Unit 5 & 6

From Short Run to Long Run

• As curve doesn't shift in response to changes in the AD curve in the short run
• I.E. - Nominal wages do not respond to price - level changes
• Workers may not realize the impact of the changes or may be under contract

Long Run

• Period in which nominal wages are fully responsive to previous changes in price level

- When changes occur in the short run, they result in either increased or decreased producer profits - not changes in wages paid.

- In the long run, increases in AD result in higher price level, as in the short run, but as workers demand mare $ the AS curve shifts left to equate production at the original output level, but not at a higher price.

- In the long run, the AS curve is vertical at the natural rate of unemployment (NRU), or full employment (FE) level of output. Everyone who wants a job has one and no one is enticed into or out of the market.

- Demand - pull inflation will result when an increase in demand shifts the AD curve to the right, temporarily increasing output while raising prices.

- Cost - push inflation results when an increase in input costs that shifts the AS curve to the left. In this case the price level increase is not in response to the increase in AD, but instead the cause of price level increasing.

Phillips Curve

• Represents the relationship between unemployment and inflation 
• The trade off between inflation and unemployment only occurs in the short run
• Given SRAS curve an increase in AD will cause price level and real output to increase which increases inflation and reduces unemployment 
• Each point on the Phillips curve corresponds to a different level of output

Long Run Phillips Curve (LRPC)

• Occurs at the natural rate of unemployment
• Represented by a vertical line 
• No trade off between inflation and unemployment in the long run
• The economy produces at the full employment output level
• Nominal wages of workers fully incorporate any changes in price level as wages adjust to inflation over the long run
• LRPC will shift only if the LRAS curve shift
• If the NRU changes the LRPC moves
• NRU is equal to frictional, seasonal, and structural unemployment

Short Run Phillips Curve (SRPC)

• Assumed to be stable because short run AS curve is stable
• If inflation persist and the expected rate of inflation rises then the entire SRPC moves upward.
• If move upward, cause of stag flation
• If inflation expectation drop due to new technologies or then the SRPC moves downward

Supply Shocks

• Rapid and significant increase in resource cost which causes SRAS to shift thus producing a corresponding shift in the SRPC

Misery Index

• Combination of inflation and unemployment in any given year
• Single digit misery is good

Stagflation

• Have high employment and inflation at the same time

Disinflation

• Inflation decreases overtime

Supply-Side Economics or Reaganomics

• Support policies that promote GDP growth by arguing that high marginal tax rates along with the current system of transfer payments (unemployment compensation & social security) provide disincitives to work invest innovate and undertake entrepreneur ventures.
• Lower tax rate induces more work thus AS decrease.
• The lower the marginal tax rate make leisure work more expensive

Laffer Curve

• Relationship between tax rates and government revenue
• The higher the tax rate you set, the less money you will collect
• Laffer curve is controversial and debatable
• As tax rates increase from 0, tax revenues increase from zero to some maximum level.

3 criticisms

1. Where the economy is actually located on the curve is difficult to determine
2. Tax cuts increase demand which can fool inflation
3. Empirical evidence suggest that the impact of tax rates on incintives was to work saving and invest are small

Trickle-Down Effect

• Call for lower taxes for the rich and less regulation to stimulate the economy

Balance of Payments

• Measure of money inflows and outflows between the U.S. and the rest of the world (ROW)
• Inflows are referred to as CREDITS
• Outflows are referred to as DEBITS
• Balance of payments is divided into 3 accounts:
• Current account
• Capital/financial account
• Official reserves account

Current Account

Balance of Trade or Net Exports

• Exports of good/services - imports of goods/services
• Exports create a credit to the balance of payments
• Imports create a debit to the balance of payments

Net Foreign Income

• Income earned by U.S. owned foreign assets - income paid to foreign held U.S assets.
• Ex.) Brazilian bonds - interest payments on German owned U.S. treasury bonds

Net Transfers (Tend to be Unilateral)

• Foreign aid  --> a debit to the current account  
• Ex.) Mexican migrant worker sends money to family in Mexico 

Capital/Financial Account

• Balance of capital ownership
• Includes the purchase of both real and financial assets
• Direct investment in the U.S is a credit to the capital account
• Ex.) Toyota factory in San Antonio 
• Direct investment by U.S. firms/individuals in a foreign country are debits to the capital account
• Ex.) The Intel Factory in San Jose, Costa Rice
• Purchase of foreign financial assets reps a debit to the capital account
• Ex.) Warren Buffet buys stock in Petrochina
• Purchase of domestic financial assets by foreigners represents a credit to the capital account
• United Arab Emirates Sovereign wealth, fund purchase a large stake in the NASDAQ

Relationship between Current and Capital Account

• Current account and the capital account should zero each other out, that is... if the current account has a negative balance (deficit), than capital account should then have a positive balance (surplus)

Official Reserves

• Foreign currency holdings of the U.S. states federal reserve system
• When there is a balance of payments, surplus the Fed accumulates foreign currency and debits for balancing of payment
• When there is a balance of payments, deficit the Fed deputes its reserves of foreign currency and credits the balance of payment
• The official reserves zero out for balance of payments 

Double Entry Bookkeeping

• Every transaction in the balance of payments is recorded twice in accordance with standard accounting practice.