Aggregate Supply and the Short-run Tradeoff Between Inflation

Aggregate Supply and the Short-run Tradeoff Between Inflation and Unemployment Done by: Abdrahman A. Bolatova B. Nursadyk N. Stanbayeva A.

Aggregate supply Is the total supply of goods and services that firms in a national economy plan on selling during a specific time period. It is the total amount of goods and services that firms are willing to sell at a given price level in an economy. Aggregate supply curve showing the three ranges: Keynesian, Intermediate, and Classical. 1

Aggregate Supply and the Phillips Curve The Phillips curve shows the short-run combinations of unemployment and inflation that arise as shifts in the aggregate demand curve move the economy along the short-run aggregate supply curve. 2

The Phillips Curve 3 Suggests: trade-off inflation for less unemployment or vice versa.

The Short-run Phillips Curve PC1 is a short-run Phillips curve the adoption of a lower inflation target moves the economy from E to A 4 Inflation rate Unemployment rate p1 p2 U1 E PC1 PC2

5 Expectations and the Short-Run Phillips Curve • Expected inflation measures how much people expect the overall price level to change. • In the long run, expected inflation adjusts to changes in actual inflation. • The central bank’s ability to create unexpected inflation exists only in the short run. - Once people anticipate inflation, the only way to get unemployment below the natural rate is for actual inflation to be above the anticipated rate.

Expectations and the Short-Run Phillips Curve Unemployment Rate = Natural rate of unemployment - a(Actual - Expected inflation) This equation relates the unemployment rate to the natural rate of unemployment, actual inflation, and expected inflation. 6

How Expected Inflation Shifts the Short-Run Phillips Curve... 7 2. …but in the long-run, expected inflation rises, and the short-run Phillips curve shifts to the right. 1. Expansionary policy moves the economy up along the shor-trun Phillips curve... low High Natural rate of unemployment

Aggregate Supply LR Aggregate supply shows the output firms wish to supply at each inflation rate in the classical model LRAS is vertical at potential output 8 Output LRAS Y Inflation

Aggregate Supply Aggregate supply (AS) shows the output firms wish to supply at each inflation rate in the classical model AS is vertical at potential output 9 Inflation Output LRAS1 Y1 LRAS2 Y2 when potential output changes LRAS shifts accordingly

Anticipatory Monetary Policy 10 Inflation Output LRAS1 AD1 AD0 A p1 F Equilibrium inflation is determined by AS and AD M  shifts AD1 to AD2

Short-run Aggregate Supply The short-run supply curve shows the relation between output supplied and inflation 11 LRAS Inflation Output SRAS AD A

Short-run Aggregate Supply Agg Demand rise AD shifts right Adjustment Process A - B - E 12 LRAS Inflation Output SRAS SRAS’ AD’ AD A B E

Short-run Aggregate Supply as inflation (along SRAS) output  & unemployment  13 AS Inflation Output SAS AD A Long run: any inflation is consistent with full unemployment (potential output) AD

Inflation and Unemployment Short-run Phillips Curve: negative relation between inflation and unemployment, given the inflation expectations built into nominal wages Long-run Phillips curve is vertical at equilibrium unemployment 14

Inflation and Unemployment The natural rate of unemployment depends on various features of the labor market. Examples include minimum-wage laws, the market power of unions, the role of efficiency wages, and the effectiveness of job search. 15

Inflation and Unemployment Society faces a short-run tradeoff between unemployment and inflation. If policymakers expand aggregate demand, they can lower unemployment, but only at the cost of higher inflation. If they contract aggregate demand, they can lower inflation, but at the cost of temporarily higher unemployment. 16

The Equilibrium Inflation Rate 17 Inflation Output LRAS AD2 AD1 A p1 Equilibrium inflation is determined by AS and AD A demand increase shifts AD1 to AD2 and inflation to B

Thanks for your attention 18