UMass Amherst ECON 104 - Effects and Cost Shocks (3 pages)

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Effects and Cost Shocks

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Effects and Cost Shocks


Chapter 13

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Lecture Note
University of Massachusetts Amherst
Econ 104 - Introduction to Macroeconomics
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ECON 104 11th Edition Lecture 20 Outline of Last Lecture I Aggregate Demand AD C G I X M a What Impacts C b What Impacts G c What Impacts I d What Impacts X M II Aggregate Supply a What Impacts AS Outline of Current Lecture I II III Fiscal Policy Effects Monetary Policy Effects Cost Shocks Stagflation Current Lecture 1 Fiscal Policy Effects a The level of net taxes is an important fiscal policy variable along with government spending b In reference to the Aggregate Supply AS Curve an expansionary fiscal policy increase in G or decrease in T shifts the Aggregate Demand AD Curve to the right assuming the economy is on the nearly flat portion of the AS Curve i When the economy is producing on the nearly flat portion of the AS Curve firms are producing well below capacity and they will respond to an increase in demand by increasing output much more than they increase prices ii Out put expands to meet the increased demand b c the price level increases a little the Fed does not raise interest rates by much and so there is little change in planned investment These notes represent a detailed interpretation of the professor s lecture GradeBuddy is best used as a supplement to your own notes not as a substitute A Shift of the AD Curve When the Economy is on the Nearly Flat Part of the AS Curve 2 Monetary Policy Effects a The Fed controls Monetary Policies b The interest rate value that the Fed chooses r depends on output Y the price level P and other factors Z the Fed achieves the interest rate value that it wants through open market operations c The issue of how much weight the Fed puts on the price level relative to output is related to the issue of inflation targeting If a monetary authority is engaged in inflation targeting then it behaves as if inflation is the only variable in its interest rate rule However the doesn t operate like this it does care about output 3 Cost Shocks Stagflation a When analyzing the effects of Cost Shocks it is the shape of the AD Curve that matters i When the AD Curve is fairly flat this is where the Fed puts a large weight on price stability relative to output In this case a leftward shift of the AS Curve results in a large decrease in output relative to the increase in the price level Behind the scenes the Fed is raising the interest rate a lot thus lowering planned investment and thus output a lot to offset much of the price effect of the Cost Shock b When the price level rises b c the AS Curve shifts to the left this is called Cost Push which is accompanied by lower output There is thus higher inflation and lower output Stagflation Positive Cost Shock

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