Unit 5: Long Run Consequences

Phillips Curve

model that shows negative relationship between inflation and unemployment in the short run

Positive Gap on the SR Phillips Curve

to the left of the LR, high inflation and low unemployment

Negative Gap on the SR Phillips curve

to the right of the LR, low inflation and high unemployment

Long Phillips curve shows

no tradeoff between inflation and unemployment, vertical at NRU

Shifters or LR Phillips curve

increasing or decreasing structural and frictional unemployment

SR Phillips curve when aggregate demand shifts

movement ALONG the SR Phillips curve in opposite direction

SR Phillips curve when SRAS shifts

phillips curve shifts up or down in opposite direction

Shifters of short run Phillips curve

supply shocks, up/down by amount of expected inflation

Velocity of money

average times a dollar is spent and respent in a year

Quantity theory of money

M x V = P x Y

money supply x velocity = Nominal GDP (price level x real output)

Relationship between price level and money supply

Change in price level = change in money supply

Budget deficit

annual government spending and transfer payments are greater than tax revenue

Budget surplus

annual government spending and transfer payments are less than tax revenue

National Debt

accumulation of all the annual budget deficits over time

Budget balance

Tax Revenues - Gov. purchases of goods and services - Gov. transfers

Government Debt

accumulation of past budget deficits minus past budget surpluses

Deficits - surpluses

Expansionary fiscal policy leads to

Deficits

Contractionary fiscal policy leads to

Surpluses

Crowding out effect

increase in government spending will cause an increase in demand for loanable funds

Loanable funds supply

Money available to be loaned out

Loanable funds demand

total amount of money borrowers want to take out

Higher demand leads to higher interest rates

Crowding out effect on supply and demand

Demand increases or supply decreases

Supply side fiscal policies

government policies designed to increase production by reducing business taxes and/or regulations

shifts LRAS

Fiscal Policy to close negative output gap

Expansionary

Increased gov. spending and lower taxes = increase AD

Monetary Policy to close negative output gap

Expansionary

Decrease interest rates, buy bonds, lower discount rates and reserve ratio = increased AD

Fiscal policy to close a positive output gap

Contractionary

decrease gov. spending, increase taxes = lowers AD

Monetary policy to close a positive output gap

Contractionary

Increase interest rates, sell bonds, increase reserve ratio and discount rates = lowers AD

Self adjustment to close negative output gap

wages and resource prices decrease = SRAS shifts right

Self adjustment to close positive output gap

wages and resource prices increase = SRAS shifts left