EC 11, Spring 2011

Bill Gibson

University of Vermont

Big ideas of the chapter Growth in postwar period averaged about 3% but not smooth

Bill Gibson

University of Vermont

Big ideas of the chapter Growth in postwar period averaged about 3% but not smooth Growth rate not smooth

Bill Gibson

University of Vermont

Big ideas of the chapter Growth in postwar period averaged about 3% but not smooth Growth rate not smooth Solow growth rate: is an economys potential growth rate,

Bill Gibson

University of Vermont

Big ideas of the chapter Growth in postwar period averaged about 3% but not smooth Growth rate not smooth Solow growth rate: is an economys potential growth rate, Would occur given flexible prices and existing real factors of production.

Bill Gibson

University of Vermont

Big ideas of the chapter Growth in postwar period averaged about 3% but not smooth Growth rate not smooth Solow growth rate: is an economys potential growth rate, Would occur given flexible prices and existing real factors of production. The Real Business Cycle (RBC) model combined with New Keynesian model

Bill Gibson

University of Vermont

Big ideas of the chapter Growth in postwar period averaged about 3% but not smooth Growth rate not smooth Solow growth rate: is an economys potential growth rate, Would occur given flexible prices and existing real factors of production. The Real Business Cycle (RBC) model combined with New Keynesian model Example Will the economy ever grow at this rate?

Bill Gibson

University of Vermont

Big ideas of the chapter Growth in postwar period averaged about 3% but not smooth Growth rate not smooth Solow growth rate: is an economys potential growth rate, Would occur given flexible prices and existing real factors of production. The Real Business Cycle (RBC) model combined with New Keynesian model Example Will the economy ever grow at this rate? Answer: : Yes, if markets are working well and prices are perfectly flexible. This is the straight line on the graph on the class web-site Bill Gibson

University of Vermont

Potential GDP

Bill Gibson

University of Vermont

Growth not smooth

Bill Gibson

University of Vermont

Employment

Bill Gibson

University of Vermont

Solow Growth Curve

Inflation Rate

Solow growth curve

3%

Real GDP growth rate Slide 5 of 51

Bill Gibson

University of Vermont

What causes the Solow curve to shift?

Positive productivity shocks:

Bill Gibson

University of Vermont

What causes the Solow curve to shift?

Positive productivity shocks: Factors that increase the fundamental ability of the economy to produce goods and services.

Bill Gibson

University of Vermont

What causes the Solow curve to shift?

Positive productivity shocks: Factors that increase the fundamental ability of the economy to produce goods and services. Negative productivity shocks:

Bill Gibson

University of Vermont

What causes the Solow curve to shift?

Positive productivity shocks: Factors that increase the fundamental ability of the economy to produce goods and services. Negative productivity shocks: Factors that decrease the fundamental ability of the economy to produce goods and services.

Bill Gibson

University of Vermont

What causes the Solow curve to shift?

Positive productivity shocks: Factors that increase the fundamental ability of the economy to produce goods and services. Negative productivity shocks: Factors that decrease the fundamental ability of the economy to produce goods and services. Example What are the parameters of the Solow model that can cause it to shift?

Bill Gibson

University of Vermont

What causes the Solow curve to shift?

Positive productivity shocks: Factors that increase the fundamental ability of the economy to produce goods and services. Negative productivity shocks: Factors that decrease the fundamental ability of the economy to produce goods and services. Example What are the parameters of the Solow model that can cause it to shift? Answer: A, s, δ, β

Bill Gibson

University of Vermont

Shifting the Solow curve

Inflation Rate

Solow growth curve

Negative shock

-1%

3%

Real GDP growth rate Slide 5 of 51

Bill Gibson

University of Vermont

Shifting the Solow curve

Inflation Rate

Solow growth curve

Positive shock

3%

7%

Real GDP growth rate Slide 5 of 51

Bill Gibson

University of Vermont

Dynamic Aggregate Demand Curve Definition: A curve showing the combinations of inflation and real growth that are consistent with a specified rate of spending growth

Bill Gibson

University of Vermont

Dynamic Aggregate Demand Curve Definition: A curve showing the combinations of inflation and real growth that are consistent with a specified rate of spending growth ˆ + vˆ = Pˆ + Yˆr M

Bill Gibson

University of Vermont

Dynamic Aggregate Demand Curve Definition: A curve showing the combinations of inflation and real growth that are consistent with a specified rate of spending growth ˆ + vˆ = Pˆ + Yˆr M Spending = inflation + real growth

Bill Gibson

University of Vermont

Dynamic Aggregate Demand Curve Definition: A curve showing the combinations of inflation and real growth that are consistent with a specified rate of spending growth ˆ + vˆ = Pˆ + Yˆr M Spending = inflation + real growth For a given level of spending growth:

Bill Gibson

University of Vermont

Dynamic Aggregate Demand Curve Definition: A curve showing the combinations of inflation and real growth that are consistent with a specified rate of spending growth ˆ + vˆ = Pˆ + Yˆr M Spending = inflation + real growth For a given level of spending growth: AD curve shows the combinations of inflation and real growth that add up to that spending growth.

Bill Gibson

University of Vermont

Dynamic Aggregate Demand Curve Definition: A curve showing the combinations of inflation and real growth that are consistent with a specified rate of spending growth ˆ + vˆ = Pˆ + Yˆr M Spending = inflation + real growth For a given level of spending growth: AD curve shows the combinations of inflation and real growth that add up to that spending growth. Can be combined with the Solow curve to give an equilibrium

Bill Gibson

University of Vermont

Dynamic Aggregate Demand Curve Definition: A curve showing the combinations of inflation and real growth that are consistent with a specified rate of spending growth ˆ + vˆ = Pˆ + Yˆr M Spending = inflation + real growth For a given level of spending growth: AD curve shows the combinations of inflation and real growth that add up to that spending growth. Can be combined with the Solow curve to give an equilibrium Example Is it common to put growth rates on axes?

Bill Gibson

University of Vermont

Dynamic Aggregate Demand Curve Definition: A curve showing the combinations of inflation and real growth that are consistent with a specified rate of spending growth ˆ + vˆ = Pˆ + Yˆr M Spending = inflation + real growth For a given level of spending growth: AD curve shows the combinations of inflation and real growth that add up to that spending growth. Can be combined with the Solow curve to give an equilibrium Example Is it common to put growth rates on axes? Answer: No! This is why this model of chpt 12 is called a dynamic AS-AD model Bill Gibson

University of Vermont

The aggregate demand growth curve

Inflation 7% 5%

5% + 0% = 5%

2%

0% -2%

2% + 3% = 5%

0%

2%

3%

5%

7%

Real Growth Slide 11 of 51 43

Bill Gibson

University of Vermont

The aggregate demand growth curve

Inflation 7% 5%

5% + 2% = 7%

2%

0% -2%

2% + 5% = 7%

0%

2%

5%

7%

Real Growth Slide 11 of 51 43

Bill Gibson

University of Vermont

AD and Solow curve determine the equilibrium

Inflation

Solow growth curve

2%

AD 3%

Real growth Slide 16 of 51 43

Bill Gibson

University of Vermont

AD and Solow curve determine the equilibrium

Inflation

7%

2%

Solow growth curve

b a

AD

3%

Real growth Slide 16 of 51 43

Bill Gibson

University of Vermont

Short run aggregate supply

Right: Upward sloping steeply

The New Keynesian Model Inflation

Solow growth curve

SRAS

2%

AD 3%

Real growth Slide 22 of 51 43

Bill Gibson

University of Vermont

Short run aggregate supply

Right: Upward sloping steeply

The New Keynesian Model Inflation

Solow growth curve

Left: Flatter because of “endowment effect” SRAS

2%

AD 3%

Real growth Slide 22 of 51 43

Bill Gibson

University of Vermont

Short run aggregate supply

Right: Upward sloping steeply

The New Keynesian Model Inflation

Solow growth curve

Left: Flatter because of “endowment effect” Three curves to determine 2 variables?

SRAS

2%

AD 3%

Real growth Slide 22 of 51 43

Bill Gibson

University of Vermont

Short run aggregate supply

Right: Upward sloping steeply

The New Keynesian Model Inflation

Solow growth curve

Left: Flatter because of “endowment effect” Three curves to determine 2 variables? Wage stickiness different in two directions

Bill Gibson

SRAS

2%

AD 3%

Real growth Slide 22 of 51 43

University of Vermont

If inflation = 2% and expected inflation is 2%

• TheNew Short-Run Aggregate Supply Curve (cont.) The Keynesian Model Inflation

Solow growth curve SRAS with expected inflation = 2%

2%

a

3%

Real growth Slide 28 of 51 43

Economy stays at point a Bill Gibson

University of Vermont

If inflation = 4% and expected inflation is 2%

• TheNew Short-Run Aggregate Supply Curve (cont.) The Keynesian Model Inflation

Solow growth curve SRAS with expected inflation = 2%

4% 2%

b a

3%

7%

Real growth Slide 27 of 51 43

Economy moves to point b Bill Gibson

University of Vermont

If inflation = 4% and expected inflation is 4%

• TheNew Short-Run Aggregate Supply Curve (cont.) The Keynesian Model Inflation

Solow growth curve

d

6% 4% 2%

c

SRAS with expected inflation 4%

SRAS with expected inflation 2%

b

a

3%

7%

Real growth Slide 26 of 51 43

Economy moves to point c Bill Gibson

University of Vermont

Demand shock-short run

• TheNew Short-Run Aggregate Supply Curve (cont.) The Keynesian Model Inflation

Solow growth curve

SRAS with expected inflation 2%

b 2%

Initial shift in AD

a

3% 5%

Real growth Slide 26 of 51 43

Economy moves to point b Bill Gibson

University of Vermont

Demand shock-long run

• TheNew Short-Run Aggregate Supply Curve (cont.) The Keynesian Model Inflation

Solow growth curve

SRAS with expected inflation 4% SRAS with expected inflation 2%

c 4%

b 2%

Initial shift in AD

a

3% 5%

Real growth Slide 27 of 51 43

Economy moves to point c Bill Gibson

University of Vermont

Depression

Bill Gibson

University of Vermont

Depression

• The Great Depression the Great Fall in AD Understanding theand Great Depression Solow growth curve

Inflation

SRAS

0% -10%

AD = C + I + G + Nx -13%

4%

Real growth Slide 48 of 51 43

Bill Gibson

University of Vermont

Summary of shocks

Bill Gibson

University of Vermont