Unit 5: Long Run Consequences

achievements of monetary policy

price stability, full employment (Yf), and economic growth

natural rate of unemployment

actual unemployment rate is this when the actual aggregate output = potential

positive output gap

UR < NRU

negative output gap

UR > NRU

short-run phillips curve (SRPC)

represents the negative short-run relationship between the unemployment rate and the inflation rate; high unemployment = low inflation; an increase in AD = increase in inflation and decrease in unemployment (E moves leftward along SRPC); demand shocks = movement along SRPC; supply shocks = shift of SRPC

long-run phillips curve (LRPC)

shows the relationship between unemployment and inflation after expectations of inflation have had time to adjust to experience; increase in inflationary expectations shift SRPC upward to expected inflation rate; to avoid accelerating inflation, the UR must match NRU; shows limits of expansionary policies

inflationary gap

left of LRPC equalibrium; unemployment rate < NRU (ever-lasting inflation)

recessionary gap

right of LRPC equalibrium; UR > NRU (decelerating inflation)

LRPC shifters

change in labor force, labor market institutions, and government policies; NRU decrease = leftward shift; NRU increase = rightward shift

long-run w/ MS increase

MS increase -> i decrease -> I increase -> multiplier increase -> AD increase -> GDPr increase -> PL increase -> wage increase -> SRAS decrease -> GDPp decrease -> PL increase

money neutrality

changes in the money supply do not have real effects on economy; in LR, an increase in MS only increases PL by an equal %

monetarism

movement that sought to eliminate macroeconomic policy activism while maintaining the importance of monetary policy; asserts GDP will increase steadily if MS does

quantity theory of money

Emphasizes the positive relationship between the price level and the money supply; dollar transactions = nominal GDP

quantity theory of money equation

Money Supply (M) x Velocity (V) = Price (P) x Real output (Y)

velocity of money

is the ratio of nominal GDP to the MS; it is a measure of the # of times the average dollar bill is spent per year; asserts that when a dollar is spent, it continues circulating in the economy; shows that total spent = value produced; if stable, steady growth of MS and GDP; when at full employment, a change in MS = no real effect on Y

velocity of money equation

(M increase) x (stable V) = (P increase) x (stable Y)

quantity theory of money in long-run

growth rate of MS determines growth rate of PL; change in nominal Ms = change in P (no effect on AD or GDPr)

budget balance equation

T (value of tax revenues) - G (gov purchases) - TR (value of gov transfers)

budget surplus

exists when tax revenues exceed government spending on goods, services, and transfer payments; T > G; occurs during inflation; becomes smaller or turns into deficit during recessions

budget deficit

exists when government spending on goods, services, and transfer payments exceed tax revenue; G > T; occurs during recessions; become smaller or turn into surpluses during inflation; if persistent, the real interest rate on loanable funds increases

cyclically adjusted budget balance

an estimate of what the budget balance would be if real GDP were exactly equal to potential output; takes into account extra tax revenue the government would collect and transfer it would recieve if recessionary gaps were eliminated

government debt

is the accumulation of past budget deficits, minus past budget surpluses; 2 issues include: crowding out of private investment and places financial burden on future budget; typically financed by sale of government bonds

default on debt

failure to pay a debt

Debt-to-GDP Ratio

is the government's debt as a percentage of GDP; good indicator of potential taxes the government can collect; can fall even if debt is rising (as long as GDP is rising faster)

implicit liabilities

spending promises made by governments that are effectively a debt despite the fact that they are not included in the usual debt statistics; EX: Medicare, Social Security

crowding out

occurs when a government deficit drives up the interest rate and leads to reduced investment spending; key concern of persistent government debt

Rule of 70

Doubling time (in years) = 70/(percentage growth rate).

labor productivity

often referred to simply as "productivity", is output per worker; sole source of LR growth; sustained growth in GDPr per capita only occurs when the amount of output produced by the average worker increases steadily

3 components of increased productivity

increased physical capital, human capital, and tech

physical capital

consists of human-made goods such as buildings and machines used to produce other goods and services; high investment of this = LR economic growth

human capital

the improvement of labor created by the education and knowledge of members of the workplace; more important than physical capital

technology

is the technological means for the production of goods/services

aggregate production function

is a hypothetical function that shows how productivity (real GDP per worker) depends on the quantities of physical capital per worker and human capital per worker as well as the state of technology.

aggregate production function equation

GDP = Y = F(physical capital, human capital, natural resources)

total factor productivity

overall efficiency of the economy in transforming inputs into outputs; affects the amount of aggregate output produced from a given level of inputs

diminishing returns to physical capital

an aggregate production function exhibits this when, holding the amount of human capital per worker and the state of technology fixed, each successive increase in the amount of physical capital per worker leads to a smaller increase in productivity

economic growth and PPC

short-run growth = movement along PPC; long-run growth = rightward shift of PPC

depreciation

occurs when the value of a physical asset is reduced by wear, age, or obsolescence; occurs with emphasis of consumer goods (SR growth, LR _____)

infrastructure

roads, power lines, ports, info. networks, and other underpinnings for economic activity

supply-side fiscal policies

government policies that seek to promote economic growth by affecting short-run and long-run aggregate supply; issue = budget; 2 categories: policies that promote private market productivity (physical capital) and policies that increase public investment in infrastructure

incentive

a reward or punishment that motivate particular choices; in supply-side policy, is motivation for household and businesses to work, save, and invest; shown through Laffer curve

Laffer curve

hypothetical relationship between tax rates and total tax revenue that slopes upward at lower tax rates (tax cut = low revenue) but turns downward at higher tax rates (tax cut = high revenue)