ECON 295 Lecture Notes - Lecture 7: Nominal Rigidity, Output Gap, Demand Shock
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17 Apr 2017
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Macroeconomics policy lecture 7 (chapter 24) Short run: determine y factor prices and technology constant. Adjustment process: y eventually returns to y* factor prices adjust (factor prices are flexible) and technology remains constant. Long run: changes in y* determine changes in y factor prices have adjusted and technology and factor supplies changes. Potential output and the output gap (i) a recessionary gap, y < y* (ii) an inflationary gap, y > y* When y > y*, the demand for labor (and other factor services) is relatively high. During an inflationary output gap there are high profits for firms and unusually large demand for labour. Wages and unit costs tend to rise. This increase in factor prices will increase firms" unit costs as unit costs increase firms will require higher prices in order to supply any given level of output as shifts up. Y moves back toward y* inflationary gap begins to close.
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