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USC ECON 205 - Aggregate Supply and Unemployment Review

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ECON 205 2nd Edition Lecture 21 Outline of Last Lecture I. The Laffer Curve and Government SpendingII. The Three Types of BudgetsIII. Aggregate Measures (Supply and Demand) and the GDPIV. Social Overhead and the Life Cycle ModelOutline of Current LectureI. Aggregate Supply, Short and Long TermII. Determinants of Aggregate SupplyIII. Sticky Wages and PricesIV. Unemployment CostsV. Inflexibility and Menu CostsCurrent LectureI. Aggregate Supply, Short and Long TermAggregate supply describes the behavior of the production side of the economy. The aggregate supply curve (AS curve) shows the level of total national output that will be produced at each price level, ceteris paribus.The short-run aggregate supply schedule is inflexible for prices and wages, leading to an upward-sloping AS curve (higher prices mean more production). Over the long-term however, most elements of the business cycle are perfectly flexible, and output is determined by potential output only. It is a vertical line. II. Determinants of Aggregate SupplyPotential output is the maximum sustainable output that can be produced without causing rising inflation. The long-term AS curve is determined by the same factors that cause economic growth, namely quantity and quality of labor, supply of capital and resources, and technology level. We measure the potential GDP at the unemployment rate NAIRU (nonaccelerating inflation rate of unemployment).An upward shift of the AS curve is caused by increases in costs of production, while an outward shift is caused by increases in potential output.Keynesian macroeconomics is associated with an upward-sloping, short-run aggregate supply. Init, changes in aggregate demand have significant effects on output. If aggregate demand falls due to monetary tightening or a falloff in spending, this will lead to falling output and prices.The long-run approach, called classical macroeconomics, says that changes in aggregate demand change prices but not real output. In the long-term, prices and wages adjust to AD. Theclassical curve is vertical; changes in AD have no effect on output.III. Sticky Wages and Prices Some elements of business costs are inflexible or sticky in the short run. Because of that, firms respond to higher demand by raising both production and prices. However, in the longer run, costs respond fully, and increased demand takes the form of higher prices. In the long run therefore, the curve is vertical.IV. Unemployment CostsEmployed persons are people who perform any paid worked, unemployed are persons that do not have a job, have actively looked for work in the prior 4 weeks, not in the labor force are the 34% of the adult population keeping house, retired, too ill to work, or not looking for work, and labor force is all employed and unemployed. The unemployment rate is the number of unemployed divided by the total labor force.High unemployment presents major problems, creating economic losses in output, psychological tolls of long periods of persistent, involuntary unemployment, and loss of self-worth. Okun’s Law relates unemployment to GDP, stating that for every 2 percent that the GDP falls relative to potential GDP, unemployment rate rises about 1%. V. Inflexibility and Menu CostsMost firms set pay scales and hire people at an entry-level wage or salary, which changes yearly.Many economists believe that the inflexibility arises because of the costs of administering compensation (menu costs). Union wages negotiation is a long process that requires worker andemployer time, but produces no output. Personnel managers therefore refer a system in which wages are argued infrequently and most workers in a firm get the same pay


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