多恩布什《宏观经济学》第十版英文原版i06revised

CHAPTER6AGGREGATESUPPLYWAGES,PRICES,ANDUNEMPLOYMENTCHAPTEROUTLINETHEPHILLIPSCURVESTAGFLATIONRATIONALEXPECTATIONSANDTHEROLEOFMISTAKESREASONSFORWAGEANDPRICESTICKINESSTHEDERIVATIONOFTHEASCURVEOKUNSLAWSUPPLYSHOCKSANDPOLICYRESPONSESCHANGESFROMTHEPREVIOUSEDITIONSECTION61HASBEENMOVEDTOCHAPTER5ANDALLTABLESANDGRAPHSHAVEBEENUPDATEDINTRODUCTIONOFTHEMATERIALCHAPTER6DEVELOPSTHETHEORYOFTHEPRICEOUTPUTRELATIONSHIPALONGTHEAGGREGATESUPPLYINMOREDETAILTHEPHILLIPSCURVE,WHICHSHOWSANEMPIRICALINVERSERELATIONSHIPBETWEENTHEUNEMPLOYMENTRATEANDINCREASESINTHENOMINALWAGERATE,CANBEEXPANDEDINTOARELATIONSHIPBETWEENINFLATIONANDUNEMPLOYMENTTHISIMPLIESTHATTHEPHILLIPSCURVEANDTHEASCURVECANBEVIEWEDASTWOALTERNATIVEWAYSTOSTUDYPRICEADJUSTMENTSTHEOLDVIEWOFTHEPHILLIPSCURVESUGGESTEDACLEARPOLICYTRADEOFFBETWEENTHERATEOFINFLATIONANDTHEUNEMPLOYMENTRATEIFTHISRELATIONSHIPHELDOVERTIME,POLICYDECISIONMAKERSCOULDALWAYSCHOOSETHEMOSTDESIRABLECOMBINATIONOFUNEMPLOYMENTANDINFLATIONALONGTHISCURVETHEBASISFORTHEPHILLIPSCURVEISTHEOBSERVATIONTHATWAGESADJUSTONLYSLOWLYTOCHANGESINTHEUNEMPLOYMENTRATETHEINFLATIONEXPECTATIONSAUGMENTEDPHILLIPSCURVEISINTRODUCEDINSECTION62HEREITISASSUMEDTHATINFLATIONARYEXPECTATIONSARECONSTANTINTHESHORTRUNALONGTHEDOWNWARDSLOPINGPHILLIPSCURVE,BUTWHENEVERINFLATIONARYEXPECTATIONSINCREASE,THESHORTRUNPHILLIPSCURVEWILLSHIFTTOTHERIGHTOUTPUTISATITSFULLEMPLOYMENTLEVELONLYIFEXPECTEDINFLATIONISEQUALTOACTUALINFLATIONTHISNEWERVIEWOFTHEPHILLIPSCURVECANALSOBEUSEDTOEXPLAINPERIODSOFSTAGFLATION,THATIS,HIGHINFLATIONINPERIODSOFHIGHUNEMPLOYMENTSTAGFLATIONOCCURSWHENTHEECONOMYMOVESTOTHERIGHTALONGAPHILLIPSCURVETHATINCLUDESAHIGHCOMPONENTOFEXPECTEDINFLATIONSINCETHEEXPECTATIONSAUGMENTEDPHILLIPSCURVEISBUILTONTHEASSUMPTIONTHATPEOPLEAREWRONGABOUTINFLATIONINAVERYPREDICTABLEWAYROBERTLUCASMODIFIEDTHEIDEAOFRATIONALEXPECTATIONSBYALLOWINGFORMISTAKESTEMPORARYDEVIATIONSFROMTHEFULLEMPLOYMENTLEVELOFOUTPUTAREPOSSIBLEDUETOFORECASTINGERRORS,BUTTHESEDEVIATIONSDONOTLASTVERYLONG,ASPEOPLEULTIMATELYRECOGNIZETHEIRERRORSINOTHERWORDS,INTHERATIONALEXPECTATIONSMODEL,MONETARYPOLICYONLYAFFECTSOUTPUTIFITISNOTANTICIPATEDHOWEVER,IFITISANTICIPATED,THENTHEPHILLIPSCURVESHIFTSALMOSTINSTANTANEOUSLYIFAPERMANENTCHANGEINMONETARYGROWTHISANTICIPATEDTHETHEORYOFAGGREGATESUPPLYISONEOFTHELEASTSETTLEDINMACROECONOMICS,WITHCOMPETINGSCHOOLSOFTHOUGHTEACHOFFERINGTHEIROWNEXPLANATIONSECONOMISTSWIDELYAGREETHATWAGES,EMPLOYMENT,ANDOUTPUTADJUSTONLYSLOWLYTOCHANGESINAGGREGATEDEMAND,BUTTHEREARESEVERALEXPLANATIONSFORTHEREASONSFORTHESLOWWAGEANDPRICEADJUSTMENTFRIEDMANANDPHELPSARGUEDTHATLABORMARKETSCANNOTCLEARRAPIDLYBECAUSEWORKERSHAVEIMPERFECTINFORMATIONORMONEYILLUSIONINTHESHORTRUNWORKERSDONOTIMMEDIATELYREALIZEWHETHERACHANGEINTHEIRNOMINALWAGEISTHERESULTOFANINCREASEINPRICESORINTHEREALWAGETHEYARERECEIVINGTHEIRSHORTRUNBEHAVIORISTHUSBASEDONNOMINALWAGES,ANDAHIGHERLEVELOFNOMINALWAGESISASSOCIATEDWITHAHIGHERLEVELOFOUTPUTLUCASUSEDASIMILAREXPLANATIONINARATIONALEXPECTATIONSCONTEXTANDHISMODELWILLBEDISCUSSEDINMOREDETAILINCHAPTER21ANOTHEREXPLANATIONENTAILSTHEEXISTENCEOFCOORDINATIONPROBLEMS,THATIS,DIFFERENTFIRMSWITHINANECONOMYCANNOTCOORDINATEPRICEORWAGECHANGESINRESPONSETOMONETARYPOLICYCHANGESUNSUREABOUTTHEBEHAVIOROFCOMPETITORS,INDIVIDUALFIRMSCHANGETHEIRPRICESORWAGESONLYRELUCTANTLYTHEEFFICIENCYWAGETHEORYARGUESTHATEMPLOYERSPAYABOVEMARKETCLEARINGWAGESTOMOTIVATETHEIRWORKERSTOWORKHARDERFIRMSAREALSORELUCTANTTOCHANGEWAGESBECAUSEOFTHEPERCEIVEDCOSTINVOLVEDINADDITION,THEREARELONGTERMRELATIONSBETWEENFIRMSANDWORKERS,THATIS,WAGESAREUSUALLYSETINNOMINALTERMSANDWAGECONTRACTSARERENEGOTIATEDONLYPERIODICALLYASPRICESCHANGEOVERTIME,REALWAGESFLUCTUATEOVERTHELENGTHOFTHEWAGECONTRACTTHEPROCESSOFADJUSTINGWAGESANDPRICESCONTINUESUNTILTHEECONOMYEVENTUALLYGETSBACKTOFULLEMPLOYMENT,BUTDURINGTHISPROCESSOUTPUTADJUSTSONLYSLOWLYTOTHECHANGESFINALLY,THEINSIDEROUTSIDERMODELARGUESTHATFIRMSNEGOTIATEONLYWITHTHEIREMPLOYEESANDNOTWITHTHEUNEMPLOYEDSINCEATURNOVERINTHELABORFORCEISCOSTLYTOFIRMS,THEYAREWILLINGTOOFFERABOVEMARKETCLEARINGWAGESTOTHECURRENTLYEMPLOYEDRATHERTHANHIRINGTHEUNEMPLOYEDWHOMAYBEWILLINGTOWORKFORLOWERWAGESITISIMPORTANTTOREALIZETHATTHESEVARIOUSEXPLANATIONSARENOTMUTUALLYEXCLUSIVEANDALLPOINTINTHESAMEDIRECTIONINTHESHORTRUNTHEASCURVEISFLAT,WHILEINTHELONGRUNITISVERTICALHOWEVER,THEMOSTINTERESTINGPRICEADJUSTMENTSOCCURINTHEMEDIUMRUN,THATIS,WHENTHEASCURVEISUPWARDSLOPINGCHAPTER6DERIVESTHEUPWARDSLOPINGASCURVEINFOURSTEPSFIRST,OKUNSLAWISUSEDTOSHOWTHECONNECTIONBETWEENOUTPUTANDUNEMPLOYMENTSECOND,THEASSUMPTIONTHATFIRMSSETPRICESASAMARKUPONLABORCOSTSISINTRODUCEDTHIRD,THEPHILLIPSCURVERELATIONSHIPISUSEDSUGGESTINGTHATCHANGESINTHERATEOFUNEMPLOYMENTINONEPERIODWILLAFFECTNOMINALWAGESINTHESUBSEQUENTPERIODFINALLY,THESERELATIONSHIPSAREUSEDTOFORMTHEMEDIUMRUNUPWARDSLOPINGASCURVE,WHICHSHOWSTHATTHEPRICELEVELINCREASESWITHTHELEVELOFOUTPUTTHEINCORPORATIONOFMATERIALPRICESINTHISANALYSISALLOWSUSTODEALWITHSUPPLYSHOCKSANINCREASEINMATERIALPRICESSUCHASANINCREASEINOILPRICESWILLSHIFTTHEUPWARDSLOPINGASCURVETOTHELEFTBECAUSEEACHUNITOFOUTPUTHASBECOMEMOREEXPENSIVEFORTHEFIRMTOPRODUCESUCHANADVERSESUPPLYSHOCKCAUSESASIMULTANEOUSINCREASEINTHERATEOFINFLATIONANDUNEMPLOYMENT,WHICHPOSESADIFFICULTPROBLEMFORPOLICYMAKERSPOLICYMAKERSCANACCOMMODATESUPPLYSHOCKSBYEXPANSIONARYDEMANDSIDEPOLICIES,BUTTHISWILLACCELERATEINFLATIONONTHEOTHERHAND,THEYCANOFFSETTHEPRICEINCREASEBYIMPLEMENTINGRESTRICTIVEDEMANDSIDEPOLICIES,BUTTHISWILLCAUSEOUTPUTTOFALLFURTHERTHEGOVERNMENTSHOULDALSOBECONCERNEDWITHWHETHERASUPPLYSHOCKISTEMPORARYORPERMANENTAFAVORABLESUPPLYSHOCK,SUCHASTHETECHNOLOGICALIMPROVEMENTSMADEINTHECOMPUTERINDUSTRY,SHIFTSTHEUPWARDSLOPINGASCURVETOTHERIGHT,LEADINGTOLOWERPRICESCOMBINEDWITHINCREASEDOUTPUTTHISISWHATTHEUSEXPERIENCEDINTHELATE1990SNOTETHATTHEANALYSISINTHETEXTBOOKISSIMPLIFIEDBYTHEASSUMPTIONTHATACHANGEINMATERIALPRICESDOESNOTAFFECTTHELEVELOFFULLEMPLOYMENTPOTENTIALOUTPUTBUTEVENIFTHELEVELOFPOTENTIALOUTPUTWEREAFFECTED,THEANALYSISWOULDNOTCHANGESIGNIFICANTLYFOREXAMPLE,IFTECHNOLOGICALINNOVATIONALSOINCREASESPOTENTIALGDP,ANDTHEREFORESHIFTSTHEVERTICALASCURVETOTHERIGHT,THENTHECENTRALBANKSHOULDLETMONEYSUPPLYINCREASEATARATEFASTENOUGHTOSHIFTTHEADCURVEINTANDEMWITHTHEASCURVETHISCOULDENSUREAPERIODOFHIGHGROWTHCOMBINEDWITHSTABLEANDLOWINFLATIONSUGGESTIONSFORLECTURINGADISCUSSIONOFTHEDIFFERENTVIEWSOFTHEPHILLIPSCURVESERVESTOSHOWSTUDENTSTHATECONOMICTHEORIESUNDERGOCHANGESOVERTIMETHEORIESAREADJUSTEDASNEWEVIDENCECOMESTOLIGHTSTUDENTSSHOULDKNOWTHATPHILLIPSORIGINALLYLOOKEDATTHERELATIONSHIPBETWEENCHANGESINTHENOMINALWAGERATEANDTHEUNEMPLOYMENTRATETHEYALSONEEDTOREALIZETHATTHEIDEAOFAPERMANENTTRADEOFFBETWEENINFLATIONANDUNEMPLOYMENTMUSTBEWRONG,SINCEUNEMPLOYMENTALWAYSEVENTUALLYADJUSTSTOITSNATURALRATETHENAIRUTHEREFOREWEHAVEAVERTICALLONGRUNASCURVEATTHEFULLEMPLOYMENTLEVELOFOUTPUTTHEINFLATIONEXPECTATIONSAUGMENTEDPHILLIPSCURVE,WHICHINCORPORATESTHEROLEOFPRICEEXPECTATIONS,CANBEUSEDTOSHOWTHEANALOGIESBETWEENTHEPHILLIPSCURVEANDTHEASCURVETHEASCURVESHOWSARELATIONSHIPBETWEENTHEPRICELEVELANDTHELEVELOFOUTPUTTHEPHILLIPSCURVESHOWSARELATIONSHIPBETWEENTHERATEOFINFLATIONANDTHEUNEMPLOYMENTRATE,GIVENCERTAININFLATIONARYEXPECTATIONSOKUNSLAWSTATESTHATTHEREISANINVERSERELATIONSHIPBETWEENCHANGESINTHEUNEMPLOYMENTRATEANDCHANGESINOUTPUT,WHICHEXPLAINSWHYTHEASCURVEISUPWARDSLOPINGBUTTHEPHILLIPSCURVEISDOWNWARDSLOPINGTHEPHILLIPSCURVESHIFTSWHENEVERINFLATIONARYEXPECTATIONSCHANGEIFWEASSUMETHATWORKERSCHANGETHEIRWAGEDEMANDSWHENEVERINFLATIONARYEXPECTATIONSCHANGE,WECANCONCLUDETHATASHIFTINTHEPHILLIPSCURVECORRESPONDSTOASHIFTINTHEASCURVE,SINCEHIGHERWAGESIMPLYHIGHERCOSTOFPRODUCTIONANOTHERWAYTODESCRIBETHERELATIONSHIPBETWEENTHEPHILLIPSCURVEANDTHEASCURVEISTOPOINTOUTTHEFOLLOWINGASHIFTINTHEADCURVEWHICHCANBESEENASAMOVEMENTALONGTHEUPWARDSLOPINGASCURVETOTHENEWMACROECONOMICEQUILIBRIUMCORRESPONDSTOAMOVEMENTALONGTHESHORTRUNPHILLIPSCURVEHOWEVER,ASHIFTINTHEUPWARDSLOPINGASCURVEDUETOACHANGEINTHECOSTOFPRODUCTIONCORRESPONDSTOASHIFTOFTHESHORTRUNPHILLIPSCURVEADISCUSSIONOFTHEPHILLIPSCURVESHOULDALSOINCLUDETHEPOSSIBILITYOFSTAGFLATION,THATIS,THESIMULTANEOUSOCCURRENCEOFHIGHINFLATIONANDHIGHUNEMPLOYMENTTHESUPPLYSHOCKSOFTHE1970SCONTRADICTEDTHEPREDICTIONSOFTHESIMPLEPHILLIPSCURVERELATIONSHIPTHATTHEREISALWAYSATRADEOFFBETWEENUNEMPLOYMENTANDINFLATIONECONOMISTSHADTOCOMEUPWITHANEXPLANATIONFORTHESIMULTANEOUSRISEINTHERATESOFUNEMPLOYMENTANDINFLATIONPHELPSANDFRIEDMANACCOMPLISHEDTHISBYINCORPORATINGINFLATIONARYEXPECTATIONSINTOTHEPHILLIPSCURVEFRAMEWORKALONGTHEPHILLIPSCURVE,INFLATIONARYEXPECTATIONSAREASSUMEDTOBECONSTANT,BUTWHENINFLATIONARYEXPECTATIONSCHANGE,THESHORTRUNPHILLIPSCURVESHIFTSINFLATIONARYEXPECTATIONSADJUSTOVERTIMETOREFLECTRECENTLEVELSOFINFLATIONTHEECONOMYISATFULLEMPLOYMENTONLYWHENEXPECTEDINFLATIONISEQUALTOACTUALINFLATIONINSUCHAFRAMEWORK,STAGFLATIONMEANSTHATWEAREONASHORTRUNPHILLIPSCURVEWITHHIGHINFLATIONARYEXPECTATIONSTOTHERIGHTOFTHENATURALUNEMPLOYMENTRATEHOWEVER,EVENTHISINFLATIONEXPECTATIONSAUGMENTEDPHILLIPSCURVEHASITSSHORTCOMINGS,SINCEITASSUMESTHATPEOPLEAREWRONGINTHEIRINFLATIONFORECASTSBUTIFPEOPLEARERATIONAL,WHYDOESNTEVERYONEADJUSTQUICKLYTONEWEXPECTATIONSABOUTTHEINFLATIONRATEIFPEOPLEKNEWTHATINTHELONGRUNMONETARYPOLICYONLYAFFECTSINFLATIONBUTNOTOUTPUTOREMPLOYMENT,WOULDNTWEALWAYSSTAYATTHEFULLEMPLOYMENTLEVELOFOUTPUTLUCASARGUEDTHATAGOODMACROECONOMICMODELSHOULDNOTBEBASEDONTHEASSUMPTIONTHATPEOPLEMAKEEASILYAVOIDABLEMISTAKESTHEREFORE,HEARGUEDTHATAPREDICTABLECHANGEINMONETARYPOLICYSHOULDHAVENOEFFECTONUNEMPLOYMENTHOWEVER,EMPIRICALDATASHOWTHATEVENANTICIPATEDMONETARYPOLICYHASREALEFFECTSONOUTPUTANDEMPLOYMENTWHYISTHISNOTPREDICTEDBYTHERATIONALEXPECTATIONSHYPOTHESISONEPOSSIBLEANSWERISTHATWAGESANDPRICESSIMPLYCANNOTADJUSTQUICKLYINSTRUCTORSSHOULDSPENDTIMEDISCUSSINGTHEDIFFERENTREASONSFORTHESLOWADJUSTMENTOFWAGESANDPRICESTHATAREPROVIDEDINTHETEXTANDASKSTUDENTSWHICHEXPLANATIONTHEYFINDMOSTCONVINCINGTHISWILLCREATEAVERYUSEFULCLASSROOMDISCUSSIONANDSTUDENTSWILLREALIZETHATTHESEDIFFERENTEXPLANATIONSARENOTMUTUALLYEXCLUSIVEAFTERTHISDISCUSSION,HOWEVER,ITMAYBEUSEFULTOLETSTUDENTSPICKONEREASONFORTHESTICKINESSOFWAGESSUCHASTHEEXISTENCEOFWAGECONTRACTSTOUSEINANYFURTHERANALYSISOFTHEEFFECTSOFPOLICYCHANGESTHISWILLAVOIDNOTONLYCONFUSIONAMONGSTUDENTS,WHOTENDTOPREFERASINGLEEXPLANATIONTOEVENVERYCOMPLEXPROBLEMS,BUTALSOTHENEEDTOREPEATEDLYDISCUSSCOMPETINGARGUMENTSFORTHESLOWWAGEANDPRICEADJUSTMENTINSTRUCTORSSHOULDALSOPOINTOUTTHATEVENTHOUGHTHETHEORYOFAGGREGATESUPPLYISBYNOMEANSSETTLEDALLECONOMISTSAGREETHATWAGESANDPRICESDOINDEEDADJUSTONLYSLOWLYTOCHANGESINAGGREGATEDEMANDTHEREFORE,EVENTHOUGHSOMEECONOMISTSARENOTHAPPYWITHTHETRADITIONALADASANALYSIS,ASIMPLEFRAMEWORKTHATEMPLOYSAVERTICALLONGRUNASCURVEBUTANUPWARDSLOPINGMEDIUMRUNASCURVECANSTILLBEVERYUSEFULWHENDISCUSSINGTHEMACROECONOMICEFFECTSOFFISCALORMONETARYPOLICYWHENEVERSTUDENTSHAVETOANALYZETHEEFFECTSOFADISTURBANCEORPOLICYCHANGE,THEYSHOULDALWAYSASKTHEMSELVESTHEFOLLOWINGTWOQUESTIONSWHICHCURVEISAFFECTED,THEADCURVEORTHEASCURVEWILLTHEDISTURBANCELEADTOANINCREASEORDECREASEINOUTPUTNATIONALINCOMETHEANSWERSWILLBEOFGREATHELPINASSESSINGWHETHERTHEIRANALYSISISCORRECTASIMPLERULEWILLHELPTOPROVIDEANANSWERTOTHEFIRSTQUESTIONIFTHECOSTOFPRODUCTIONISAFFECTED,THENTHEASCURVEWILLSHIFTALLOTHERDISTURBANCESWILLSHIFTTHEADCURVEANEXCEPTIONTOTHISRULEISSUPPLYSIDEECONOMICS,WHICHWILLSHIFTBOTHTHEASANDTHEADCURVESTHEANSWERTOTHESECONDQUESTIONWILLTELLSTUDENTSWHETHERTHEADCURVEORTHEASCURVEWILLSHIFTTOTHERIGHTORLEFTITISALWAYSBETTERTOTHINKOFASHIFTTOTHE“RIGHTORLEFT”RATHERTHANOFASHIFT“UPORDOWN”FOREXAMPLE,ANADVERSESUPPLYSHOCKSHIFTSTHEASCURVETOTHELEFTSOMESTUDENTSMAYEASILYINTERPRETTHISASASHIFT“UP,”SINCEWEWILLENDUPATAHIGHERPRICELEVELHOWEVER,INACTUALITY,THEAGGREGATESUPPLYGOES“DOWN,”SINCETHELEVELOFOUTPUTDECREASESTWOMOREPOINTSSHOULDBEKEPTINMINDINSUCHANANALYSISFIRST,AFTERANINITIALEQUILIBRIUMHASBEENESTABLISHEDATTHEINTERSECTIONOFTHEADCURVEWITHTHEUPWARDSLOPINGASCURVE,THELONGRUNADJUSTMENTWILLALWAYSINVOLVEANADJUSTMENTOFNOMINALWAGES,THATIS,ACHANGELABORCOSTSTHISADJUSTMENTWILLTAKEPLACETHROUGHCONTINUOUSSHIFTSOFTHEUPWARDSLOPINGASCURVETOWARDSTHEFULLEMPLOYMENTLEVELOFOUTPUTTHELONGRUNVERTICALASCURVEATYSECOND,THELONGRUNOUTCOMEISALWAYSEQUALTOTHEOUTCOMEINTHECLASSICALCASE,SINCENOMINALWAGESAREASSUMEDTOBECOMPLETELYFLEXIBLEINTHELONGRUNMOSTSTUDENTSSHYAWAYFROMTHEMATHEMATICALDERIVATIONSPRESENTEDINTHISCHAPTERTHEYPREFERNOTTOGOTHROUGHALLOFTHESTEPSTHATARENEEDEDTODERIVEEQUATIONS8AND9,WHICHAREVERSIONSOFTHEUPWARDSLOPINGASCURVEWHILETHEMATHEMATICALDERIVATIONOFTHESEEQUATIONSISNOTVERYDIFFICULT,INSTRUCTORSMAYCHOOSENOTTODEVOTECLASSTIMETOIT,LEAVINGITUPTOTHEMOREMOTIVATEDSTUDENTSTODOITONTHEIROWNBUTINSTRUCTORSSHOULDGIVESTUDENTSATLEASTABRIEFEXPLANATIONOFTHEREASONSFORANUPWARDSLOPINGAGGREGATESUPPLYCURVE,WHICHASSUMESLESSTHANFULLYFLEXIBLEWAGESAPOSITIVEPRICEOUTPUTRELATIONSHIPIMPLIESTHATFIRMSAREWILLINGTOSUPPLYMOREOUTPUTASPRICESGOUPINCREASEDOUTPUTIMPLIESREDUCEDUNEMPLOYMENTOKUNSLAWANDTHUSINCREASEDLABORCOSTSASOKUNSLAWISDISCUSSED,INSTRUCTORSMAYWANTTODRAWATTENTIONTOTHEOUTPUTGAPASWELLASTHEUNEMPLOYMENTGAPWHENEVERLABORCOSTSANDTHUSTHECOSTOFPRODUCTIONINCREASE,THEUPWARDSLOPINGASCURVEWILLSTARTTOSHIFTTOTHELEFTTHEADJUSTMENTPROCESSWILLSTOPWHENINFLATIONARYEXPECTATIONSAREFULFILLED,ANDANEWLONGRUNEQUILIBRIUMISREACHEDATTHEFULLEMPLOYMENTLEVELOFOUTPUTINSTRUCTORSMAYFINDITWORTHWHILETOSPENDEXTRATIMEPRESENTINGTHEMATERIALOFTHISCHAPTER,ASTHETHEORYOFAGGREGATESUPPLYISONEOFTHEMOSTCONTROVERSIALINMACROECONOMICSMASTERYOFTHEKEYCONCEPTSINTHISCHAPTERWILLMAKETHEMATERIALINTHEFOLLOWINGCHAPTERSEASIERTOCOMPREHENDWHENEXPLAININGTHEREASONSFORWAGEANDPRICESTICKINESS,THEDIFFERENCESBETWEENMICROECONOMICSANDMACROECONOMICSSHOULDBECOMEAPPARENTINTHEDISCUSSIONOFTHEASCURVE,ITISALSOIMPORTANTTOCLEARLYSTATETHEFOLLOWINGPROPERTIESTHEASCURVEBECOMESSTEEPERASWAGESADJUSTTOCHANGESINUNEMPLOYMENTMORERAPIDLYWAGESBECOMECOMPLETELYFLEXIBLEINTHELONGRUN,SOTHEASCURVEBECOMESVERTICALANDWEHAVETHECLASSICALCASETHEPOSITIONOFTHEUPWARDSLOPINGASCURVEDEPENDSONTHEPRICELEVELTHATEXISTEDINTHEPREVIOUSTIMEPERIODASLONGASOUTPUTISABOVEBELOWTHEFULLEMPLOYMENTLEVELTHEREWILLBEUPWARDDOWNWARDPRESSUREONWAGESANDPRICESANDTHEREFORETHEUPWARDSLOPINGASCURVEWILLSHIFTTOTHELEFTRIGHTAFTERADEMANDSIDEDISTURBANCE,THEADJUSTMENTTOANEWLONGRUNMACROEQUILIBRIUMISACHIEVEDTHROUGHASERIESOFSHIFTSINTHEUPWARDSLOPINGASCURVEUPTOTHEPOINTATWHICHTHENEWADCURVEINTERSECTSTHEVERTICALASCURVEATTHEFULLEMPLOYMENTLEVELOFOUTPUTANEGATIVEPOSITIVESUPPLYSHOCKWILLSHIFTTHEUPWARDSLOPINGASCURVETEMPORARILYTOTHELEFTRIGHTBUTIFTHEREISNOPOLICYRESPONSE,THELONGRUNADJUSTMENTWILLEVENTUALLYGETUSBACKTOTHEORIGINALPOSITIONASSUMINGTHATPOTENTIALOUTPUTISNOTAFFECTEDHOWEVER,ITSHOULDBENOTEDTHATAFTERANADVERSESUPPLYSHOCKANINCREASEINOILPRICESTHEECONOMYONLYWILLARRIVEATANEWLONGRUNEQUILIBRIUMIFNOMINALWAGESDECREASETHISMEANSTHATSOMEINCOMEREDISTRIBUTIONHASTOTAKEPLACEAWAYFROMWORKERSANDINTOTHEPOCKETSOFOILPRODUCERSASSIGNINGEXERCISESINWHICHTHEEFFECTSOFPOLICYCHANGESHAVETOBEANALYZEDWILLHELPSTUDENTSTOGETABETTERUNDERSTANDINGOFTHEMATERIALFOREXAMPLE,ANINTERESTINGDEBATECANBESTARTEDBYPRESENTINGSTUDENTSWITHASERIESOFPOSSIBLEPOLICYRESPONSESTOANADVERSESUPPLYSHOCKTHISCANBEDONEMOSTEASILYWITHTHEHELPOFASERIESOFASADDIAGRAMSTHESEPOLICYRESPONSESARE1EXPANSIONARYMONETARYPOLICY2RESTRICTIVEMONETARYPOLICY3DONOTHING4SUPPLYSIDEPOLICIES5INCOMESPOLICIESSUCHASWAGEPRICECONTROLSORGUIDELINESTHEFIRSTPOLICYOPTIONWILLLEADTOAQUICKRETURNTOFULLEMPLOYMENT,BUTATTHECOSTOFHIGHERINFLATION,WITHTHEADDEDDANGEROFENTERINGAWAGEPRICESPIRAL,ASWORKERSMAYREACTTOHIGHERINFLATIONBYASKINGFORHIGHERWAGESTHESECONDOPTIONEVENTUALLYACHIEVESALOWERRATEOFINFLATION,BUTATTHECOSTOFANEXTENDEDPERIODOFHIGHUNEMPLOYMENTTHISCANBEVERYPAINFULTOTHOSELOSINGTHEIRJOBSANDIMPLIESASUBSTANTIALLOSSOFOUTPUT,ESPECIALLYIFWAGESANDPRICESAREVERYSTICKYFROMTHEDISCUSSIONOFTHESETWOOPTIONS,STUDENTSGRASPTHATDEMANDMANAGEMENTINTHECASEOFANADVERSESUPPLYSHOCKISNOTAVERYGOODOPTIONSTUDENTSMAYSEE“DONOTHING”ASTHEBESTOPTION,SINCEITWILLEVENTUALLYGETTHEECONOMYBACKTOTHEORIGINALEQUILIBRIUMPOINTHOWEVER,SOMEINCOMEREDISTRIBUTIONWILLHAVETOTAKEPLACEANDTHEPROCESSMAYBEVIEWEDASUNACCEPTABLYSLOWTOPOLICYDECISIONMAKERSHERETHEDISTINCTIONOFAPERMANENTVERSUSATEMPORARYDISTURBANCEISIMPORTANTTHESUPPLYSIDEOPTIONHASBEENDISCUSSEDINTHEPREVIOUSCHAPTERAND,ASWEHAVESEEN,ISANYTHINGBUT“ASIMPLESOLUTION”ASRONALDREAGANONCEPUTITWHILECHAPTER6DOESNOTDISCUSSTHEEFFECTSOFWAGEPRICECONTROLSORGUIDELINES,INSTRUCTORSMAYWANTTODISCUSSTHISOPTIONANYWAY,SINCEITHASBEENTRIEDINTHEPASTWITHOUTMUCHSUCCESSANDPRESENTSANOTHEROPPORTUNITYTOSTRESSTHEROLEOFINFLATIONARYEXPECTATIONSCLEARLY,SPENDINGTIMEONDISCUSSINGSOMANYOPTIONSCOMESATAPRICENOTONLYISVALUABLECLASSTIMETAKENUPBUTSTUDENTSMAYBECOMEFRUSTRATEDWHENDEALINGWITHMORETHANTWOPOLICYALTERNATIVESONTHEOTHERHAND,STUDENTSNEEDTOBEAWARETHATGOVERNMENTDECISIONMAKERSHAVEAWHOLEARRAYOFPOLICYOPTIONSATTHEIRDISPOSAL,BUTNONEOFTHEMMAYBEPARTICULARLYAPPEALINGINAGIVENSITUATIONADDITIONALREADINGSAKERLOF,GANDYELLEN,J,“ANEARRATIONALMODELOFTHEBUSINESSCYCLE,WITHWAGEANDPRICEINERTIA,”QUARTERLYJOURNALOFECONOMICS,SUPPLEMENT,1985BALL,LMANDMANKIW,NG,“THENAIRUINTHEORYANDPRACTICE,”JOURNALOFECONOMICPERSPECTIVES,NOVEMBER,2002BLANCHARD,OANDKATZ,L,“WHATWEKNOWANDDONOTKNOWABOUTTHENATURALRATEOFUNEMPLOYMENT,”JOURNALOFECONOMICPERSPECTIVES,WINTER,1997BRIDGMAN,BANDTREHAN,B,“WHATDOWAGESTELLUSABOUTFUTUREINFLATION”ECONOMICLETTER,FRBOFSANFRANCISCO,JANUARY19,1996CHANG,ROBERTO,“ISLOWUNEMPLOYMENTINFLATIONARY”ECONOMICREVIEW,FRBOFATLANTA,FIRSTQUARTER,1997COY,PETER,“DIDTHESUPPLYSIDERSJUSTGETSIDESWIPED”BUSINESSWEEK,APRIL21,2003ESPINOSAVEGA,MANDRUSSELL,S,“HISTORYANDTHEORYOFTHENAIRUACRITICALREVIEW,”ECONOMICREVIEW,FRBOFATLANTA,SECONDQUARTER,1997FRIEDMAN,MILTON,“THEROLEOFMONETARYPOLICY,”AMERICANECONOMICREVIEW,MARCH,1968GALBRAITH,JAMES,“TIMETODITCHTHENAIRU,”JOURNALOFECONOMICPERSPECTIVES,WINTER,1997GORDON,ROBERT,J,“FOUNDATIONSOFTHEGOLDILOCKSECONOMYSUPPLYSHOCKSANDTHETIMEVARYINGNAIRU,”BROOKINGSPAPERSONECONOMICACTIVITY,NO2,1998HANES,CHRISTOPHER,“NOMINALWAGERIGIDITYANDINDUSTRYCHARACTERISTICSINTHEDOWNTURNSOF1893,1929,AND1981,”AMERICANECONOMICREVIEW,DECEMBER,2000KOENIG,EVAN,“ISTHEFEDSLAVETOADEFUNCTECONOMIST”SOUTHWESTECONOMY,FRBOFDALLAS,SEPTEMBER/OCTOBER,1997LESSON,ROBERT,“THEPOLITICALECONOMYOFTHEINFLATIONUNEMPLOYMENTTRADEOFF,”HISTORYOFPOLITICALECONOMY,SPRING,1997LINDBECK,ASSAR,“MACROECONOMICTHEORYANDTHELABORMARKET,”EUROPEANECONOMICREVIEW,VOL36,1992LUCAS,ROBERT,E,“SOMEINTERNATIONALEVIDENCEONOUTPUTINFLATIONTRADEOFFS,”AMERICANECONOMICREVIEW,JUNE,1973MANKIW,GREGORY,“