AS UE
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# 🌟 **Chapter 13 Summary Notes
Aggregate Supply & the Short-Run Tradeoff Between Inflation and Unemployment**
*(Mankiw, 7th ed.)*
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## **1. Why Aggregate Supply Matters**
In the **long run**, prices are flexible → **AS curve is vertical** → output stays at its natural level.
In the **short run**, some prices are sticky → **AS curve slopes upward** → output fluctuates when AD shifts.
Two models explain short-run AS:
* **Sticky-Price Model**
* **Imperfect-Information Model**
Both lead to the same conclusion:
👉 *Output deviates from its natural level when actual prices differ from expected prices.*
General AS form:
**Y – Ȳ = a(P – Pᵉ)**, where a > 0.
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# **2. The Phillips Curve**
The Phillips Curve translates AS behavior into inflation-unemployment terms.
### **Modern Phillips Curve Equation:**
**π = πᵉ – b(u – uₙ) + v**
Where:
* **π** = inflation
* **πᵉ** = expected inflation
* **u – uₙ** = cyclical unemployment
* **v** = supply shock
* **b** = responsiveness of inflation to unemployment
Key ideas:
* Higher unemployment → pulls inflation **down** (demand-pull effects).
* Supply shocks → push inflation **up or down** (cost-push effects).
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# **3. Adaptive Expectations & Inflation Inertia**
If people expect the future based on last year’s inflation → **adaptive expectations**.
Thus:
**πᵉ = π₋₁** → inflation has **inertia** — it continues unless something disrupts it.
Inflation inertia happens because:
* Workers/firms base wage-price decisions on past inflation.
* Expected inflation shifts short-run AS upward over time.
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# **4. Demand-Pull vs. Cost-Push Inflation**
### **Demand-Pull Inflation**
High aggregate demand → low unemployment → inflation rises.
### **Cost-Push Inflation**
Adverse supply shock (e.g., oil price hike) → costs rise → inflation rises.
Favorable shock → inflation falls.
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# **5. The Short-Run Tradeoff (The Phillips Curve Graph)**
In the **short run**, policymakers can choose a point on the short-run Phillips curve:
* **Lower unemployment → higher inflation**
* **Higher unemployment → lower inflation**
The position of the curve depends on **expected inflation**:
* Higher expected inflation → curve shifts upward → worse tradeoff
* Lower expected inflation → curve shifts downward
In the **long run**, expectations adjust → curve becomes vertical at **uₙ** → **no tradeoff**.
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# **6. Disinflation & the Sacrifice Ratio**
**Disinflation** = reducing inflation.
The Phillips curve implies:
👉 Lowering inflation requires **higher unemployment and lower output** (in the absence of shocks).
**Sacrifice Ratio** = % of a year’s GDP that must be lost to reduce inflation by 1%.
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# **7. Rational Expectations & Painless Disinflation**
Some economists argue that if people believe the policy, inflation can fall **without** unemployment rising:
Requirements:
1. Policy to reduce inflation is **announced early**
2. Policy is **credible**
If both are met → expectations drop quickly → short-run Phillips curve shifts down → **“painless disinflation.”**
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# **8. Historical Evidence (U.S. Case Study)**
* **1960s:** Low unemployment → demand-pull inflation.
* **1970s:** Oil shocks → cost-push inflation (stagflation).
* **1980s:** Tight monetary policy → high unemployment → inflation fell.
These periods illustrate:
* Both **demand-pull** and **cost-push** forces
* Short-run vs. long-run differences
* Role of expectations
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# **9. Hysteresis**
Idea:
A recession might increase the **natural rate of unemployment** (uₙ) permanently because:
* Long-term unemployed lose skills
* Firms’ hiring behavior changes
Thus, temporary high unemployment may cause lasting damage.
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# **🔥 Quick Quiz Guide (What They Usually Ask)**
If you see a surprise quiz, expect these types of questions:
### **Concept IDs**
* Sticky vs flexible prices
* Natural rate of unemployment
* Demand-pull vs cost-push inflation
* Adaptive vs rational expectations
* Sacrifice ratio
* Stagflation
### **Graphs**
* Short-run Phillips curve shifts
* AD–AS shifts with supply shocks
* Long-run Phillips curve (vertical)
### **Short Explanations**
* Why short-run tradeoff disappears long-run
* How expectations determine inflation
* Why disinflation can be costly or painless