ECON-002 Lecture Notes - Lecture 24: Potential Output, Market Basket, Demand Curve

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5 Jun 2017
April 25th, 2017
The Inflation Adjustment Line (IA)
-The economy can produce any level of output in the short
run without affecting the inflation rate
-the curve makes us think inflation is going to be stable;
people think the expectations are going to be stable, and in
the end it is
Measuring Expectations:
-surveying consumers
In 1980-2015: the expected inflation is stable (about 3%);
expectations for inflation are relatively stable —> this is one
reason why the IA line is flat. (Look at slide 6/22)
Why is the IA line flat?
1. Expectations of continuing inflation (people expect it to be the same, which does keep it the
2. Staggered wage setting
-labor union contracts (these tend to be negotiated every 3 years)
-every year, about 1/3 of the contracts in the labor force is being reevaluated
-contracts or not: wages are not all set simultaneously
-there are always going to be people who are just starting to work; they are going to base
their wage requests on what they see in the economy; current wages depend on past wages
3. Staggered price setting
-firms get to decide what they want for prices on certain objects
-the prices that they decide depend on prices that have already been set
-Mark Bils: studies price setting by looking at items in the CPI market basket
-while some prices change all the time (gas), some prices change infrequently (catalog items)
What things shift this line?
1. if the level of GDP is not the same as potential GDP —> YY*
-f actual production is above potential or is below potential
-if GDP is below potential, the line shifts down; if it is above potential, the line shifts up
2. A change in inflationary expectations
3. A “price shock”
-an increase in the price of something that is very important to the economy (EX: food prices or
oil prices)
Combining the Parts: The Economic Fluctuations Model:
Spending Curve, Monetary Rule
Curve, Aggregate Demand Curve
(The point where IA=Y is
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