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Department
Economics for Management Studies
Course
MGEA06H3
Professor
Iris Au
Semester
Winter

Description
Chapter 24 From the Short Run to the Long Run: The Adjustment of Factor Prices Notes N defining characteristics of short run in macroeconomic model are: o factor prices are assumed to be exogenous; they may change, but any change is not explained within the model o technology and factor supplies are assumed to be constant (and therefore Y* is constant) N theory of adjustment process that takes the economy from short run to long run is based on following assumptions: o factor prices are assumed to be flexible and to adjust to output gaps o technology and factor supplies are assumed to be constant (and therefore Y* is constant) N defining characteristics of long run in macro model are: o factor prices are assumed to have fully adjusted to any output gap o technology and factor supplies are assumed to be changing 24.1 The Adjustment Process Potential Output and the Output Gap N potential output is total output that can be produced when all productive resources are being used at normal rates of utilization N when a nations actual output diverges from its potential output, difference is called output growth Factors Prices and the Output Gap N when real GDP is above potential output, demand for factors will be high and there will be pressure on factor prices to rise N when real GDP is below potential output, demand for factors will be low and there will be pressure on factor prices to fall N boom that is associated with an inflationary gap generates a set of conditionshigh profits for firms and unusually large demand for labourthat tends to cause wages (and other factor prices) to rise N the slump that is associated with a recessionary gap generates a set of conditionslow profits for firms and low demand for labourthat tends to cause wages (and other factor prices) to fall N both upward and downward adjustments to wages and unit costs do occur, but there are differences in the speed at which they typically operate; booms can cause wages to rise rapidly; recessions usually cause wages to fall only slowly N Phillips curveoriginally, a relationship between the unemployment rate and the rate of change of money wages; now often drawn as a relationship between GDP and the rate of change of money wages Potential Output as an Anchor N following an aggregate demand or supply shock, the short-run equilibrium level of output may be different than potential output; any output gap is assumed to cause wages and other factor prices to adjust, eventually bri
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