Unit 6

Long-Run Economic Growth, Phillips Curves, and the Laffer Curve

• Focus on Real GDP per Capita
• Last 50 Years Real GDP grew by about 3.5% per year
• Last 50 Years Real GDP per Capita grew by about 2.3% per year

The Sources of Long-Run Growth:

• Productivity—output per unit of input
• Labor Productivity – output per worker
* What leads to higher productivity?
* Stock of Physical Capital – buildings, machines, robots, etc.
* Human Capital – Knowledge, skills, educations, etc.
* Technology – technical means for producing goods and services
* Improved Resource Allocation – Trade allows us to shift labor services from low-productive jobs to high productive jobs.
* Economies of Scale – reductions in per-unit cost that result from increases in the size of markets and firms.

Production Possibilities Curve and LRAS:

• Economic Growth = Shift in Production Possibilities Curve outward
• Economic Growth = Shift in the Long-Run Aggregate Supply Curve to the RIGHT

Why Growth Rates Differ among Countries:

• Rates of Savings
• Foreign Investment
• Education
• Infrastructure – roads, power lines, ports, and information networks, etc.
• Research and Development
• Political Stability
• Protection of Property Rights
• Economic Freedom versus Excessive Government Intervention

The Phillips Curves – Short and Long Run

• Tradeoff between inflation and unemployment
• Stagflation leads to shifts in the SRPC.
* Aggregate Supply Shocks: Oil Embargo, Major Agriculture Shortfalls, Depreciating U.S. Dollar, Wage Hikes, Inflationary Expectations.
• Long-Run Phillips Curve (LRPC)
* Vertical line at the natural rate of unemployment

Supply-side Economics and the Laffer Curve

• Stress that changes in Aggregate Supply are an active force in determining the levels of inflation, employment, and economic growth.
• Concentrate on tax levels
• Lower taxes are an incentive for business to invest in our economy
• Lower taxes are an incentive for workers to work more and harder thereby becoming more productive.
• Lower taxes are incentives for people to increase savings and therefore create lower interest rates for increases in business investment
• Focus on the marginal tax rates

The Laffer Curve:
• Relationship between tax rates and tax revenues
• Used to support the supply-side argument
• Reaganomics = Supply-Side Economics
• Idea = The government could lower tax rates and actually increase tax revenues.
• Has been severely criticized.

Unit 5

Unit 5
Sras- time too short for wages to adjust to the price level. The reason is that workers may not be aware of changes in their real wages due to inflation therefore they adjust their labor decisions accordingly as well as wage demands.

Nominal wage- is the amount of money received per day, per hour, per year
Real wage- adjusted for inflation and everything else.

Long run AS- time long enough for wages to adjust to the price level. Key assumptions:
1. Wage and price is flexible
2. Changes in wage and price offset eachother
3. LRAS = vertical line
4. Changes:

Phillips Curve:

3 generalization:
-Inverse relationship between inflation and unemployment
-Aggregate supply shock can case higher rates of inflation and higher rates of unemployment
-No significant trade off between inflation and unemployment in the long run

If inflation persists, and the expected rate if inflation rises then the entire SRPC moves upwards (stagflation is possible or probably)
If inflation expectations drop due to new technology then the SRPC moves downwards.

Increase in AD = up/ left movement along SRPC
Decrease in AD = down\ right along SRPC

*SRPC label at the bottom

SRAS -> = <- SRPC

SRAS <- = -> SRPC (Stagflation)

LRPC:
-vertical at full employment
-major LRPC assumption is that more worker benefit create higher natural rates of unemployment and fewer worker benefit create fewer natural rate of unemployment

-shift= same as LRAS

Misery index:
-a combination of inflation and unemployment in a given year.
-single digit misery is good.

*seasonal, structional, frictional = Natural rate of unemployment

Supply Shock- it is a rapid an significant increase in resource prices which cause the SRAS to shift which results in producing a shift in the SRPC curve.
Ex: Oil embargo
increase in input prices
Wage height
(Positive or negative)

Disinflation- reduction in inflation rate from year to year which can be seen in the long run Phillips curve.


Stagflation- increase in inflation and unemployment.


Supply side economics(Raeganomics) -Tends to believe AS curve will determine levels of inflation, unemployment, and economic growth.

Increase economy= shift AS right

-focus on marginal tax rate

Marginal tax rate- amount of tax payed on an addition dollar of income

* by reducing marginal tax rate it will encourage more people to work longer

* high marginal tax rates may end up reducing savings since when you save money you are then taxed at a higher rate on your profit of interest

As tax rate increase from zero, tax revenues increase from zero to maximum number then they decline.

3 criticisms of laffer curve:
1. Where the economy is actually located on the curve is difficult to determine.
2. Tax cuts increase demand which can fuel inflation and demand may exceed supply
3. Research states that tax rates impact peoples incentives to work, invest and save.