Study Notes on Economic Concepts and Phillips Curve

The Economy in the Short Run and in the Long Run

Week 12 (4/20-4/24/2026) Schedule Overview

• Focus on how trade affects Aggregate Demand (AD).

• Explore differences between long run and short run in macroeconomics.

• Chapters to read:
      - Chapter 35, pp. 836-853 (HC)
      - Chapter 19 (OC), pp. 460-486

• Practice multiple choice questions (MCQ) relating to Exchange Rates and Capital Flows.

Trade's Effect on Aggregate Demand

• Trade can influence the AD in terms of net exports (Xn).

• An increase in exports boosts AD, while an increase in imports reduces it.

• Changes in exchange rates can affect relative prices of domestic/foreign goods.

Long Run vs Short Run

• Short Run: Adjustments to changes in demand/supply occur; output can deviate from potential GDP.

• Long Run: All prices are flexible, and output returns to potential GDP (represented by Long-Run Aggregate Supply, LRAS).

Review of Previous Week (Week 11)

• Recapped key concepts from Unit 4, focusing on:     - Balance of Payments (BOP) and its differences between Capital/Financial accounts.     - Exchange Rates and the reading assignments focused on understanding theoretical foundations and graphs   

Exchange Rate and Capital Flows Practice

• Exchange Rate Definition: Price of one currency in terms of another currency.

• Practice Problems:
      - Determining currency exchange values and implications for trade.     - Assess how changes in exchange rates affect demand for exports and imports.   

Calculations Involving Currency Exchange

• Use to convert foreign goods prices into USD:
      - $ext{Foreign Price} imes rac{1}{ ext{Forex to Dollar Rate}}$
      - Example: Ticket to the Louvre costs 32 Euros; price in USD depends on current exchange rate.

Currency and Net Exports

• Example: If the US dollar is stronger than the Canadian dollar:     - US Exports decrease (Canadian goods become expensive).     - US Imports increase (Canadian goods become cheaper).

• Changes must be illustrated on an AS-AD graph, indicating shifts in AD and potential changes in price levels (PL), output, and unemployment.

Interest Rates and Capital Flow

• Interest rates impact capital flows significantly; if interest rates rise, capital inflows generally increase.

• Monetary Policy Effects:
      - Raising the reserve requirement or discount rate can increase interest rates, thus affecting capital flow dynamics.     - Changes in financial markets lead to variations on foreign exchange graphs.

Interest Rates Historical Context

• Since 2021, interest rates climbed over 4%.

• Japan's increased investment in US treasury bonds highlights international capital movement influenced by these interest rate fluctuations.

Phillips Curve and Economic Policies

• Short-Run Phillips Curve (SRPC): Inverse relationship between inflation and unemployment.

• Long-Run Phillips Curve (LRPC): Vertical at the natural rate of unemployment; indicates no trade-off and the economy’s full employment potential.

• The application to inflationary and recessionary gaps must be recognized in graphing exercises.

Monetary and Fiscal Policies

• Monetary Policy Steps:
      - Expansionary: Lower discount rates or reserve requirements to encourage lending.     - Contractionary: Raise rates to slow the economy.

• Fiscal Policy Examples:
      - Increase spending for economic growth during recessions vs. reduce spending to manage inflation.

Unemployment Types and Definitions

• Types of Unemployment:     - Frictional: Transition between jobs, typically short-term.     - Structural: Mismatch of worker skills and job requirements (e.g., technological changes).     - Cyclical: Related to downturns in economic cycles.

• Unemployment Rate Calculation: $ext{Unemployment Rate} = rac{ ext{Unemployed}}{ ext{Labor Force}} imes 100$

Wage Definitions

• Minimum Wage: Acts as a price floor; can lead to surplus in the labor market.

• Efficiency Wages: Higher than market wages can lead to increased productivity.

• Sticky Wages: Wages that adjust slowly due to contracts or market resistance. Influences AD and labor demand.

Inflation and Its Costs

• Costs:
      - Shoe-Leather Costs: Frictional costs associated with reducing cash holdings.     - Menu Costs: Costs of adjusting prices (e.g., reprinting catalogues).

• Disinflation vs. Deflation:     - Disinflation: Slowing rate of inflation.     - Deflation: Decrease in overall price levels; can stimulate negative economic consequences.

Non-Accelerating Inflation Rate of Unemployment (NAIRU)

• The unemployment level where inflation does not accelerate. Similar to the natural rate, creating upward pressure on costs as demand for labor rises.

Key Takeaways on Phillips Curve Interactions

• Observations on adverse supply shocks reveal an upward shift in SRPC, where both inflation and unemployment increase.

• The implications of inflationary expectations and the relationship between expected and actual inflation levels impact economic forecasting and policy responses.