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Chapter 24

Economics 102: Chapter 24

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ECON 102
Robert Gateman

Economics 102: Principles of Macroeconomics Chapter 24 Short Run:  Factor prices are assumed to be exogenous (prices may change, but not explained in the model)  Technology and factor supplies are assumed to be constant (Y* is constant)  The real level of GDP fluctuates around the constant level of Y*  AD/AS shocks cause Y to fluctuate around constant Y* The Adjusting of Factor Prices:  Factor prices are assumed to adjust in response to output gaps  Technology and factor supplies are assumed to be constant (Y* is constant)  Wages and other factor prices adjust as real GDP fluctuates in comparison to Y*  Following AD or As shocks, Y eventually returns to Y* Long Run:  Factor prices are assumed to have fully adjusted to any output gap  Technology and factor supplies are assumed to be changing (the level of Y* is able to change)  Changes in Y* determine changes in Y 24.1 The Adjustment Process Potential Output and the Output Gap:  Potential output: output when all production resources are at their normal rate of utilization o Output gap: difference between a nation's actual output and potential output o Recessionary gap: real GDP is less that potential GDP o Inflationary gap: real GDP is more than potential GDP Factor Prices and the Output Gap:  During inflationary periods there will be upward pressure on prices because of demand  During recessionary periods there will be downward pressure on price from lower demand o Even if there is no output gap, the effects of inflation influence factor prices Output Above Potential (Y>Y*):  When firms produce beyond their normal capacity their demand for labour increases o When labour shortages emerge, the price of labour increases  Firms also earn high profits during this boom that is associated with inflationary gaps o AS will shift up with higher unit costs and causes real GDP to drop and the price to rise  Real GDP movers back toward potential, inflationary gap begins to close  Factor price increases will continue until the AS shifts down and Y is at the level of Y* Output Below Potential (Y
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