economics for managers gtu mba sem 1 chapter 33
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7/31/2019 Economics For Managers GTU MBA Sem 1 Chapter 33
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By:
Prof. Sharif Memon
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The natural rate of unemployment
depends on various features of the
labor market.
Examples include minimum-wage laws,
the market power of unions, the role of
efficiency wages, and the effectivenessof job search.
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Society faces a short-run tradeoff between
unemployment and inflation.
If policymakers expand aggregatedemand, they can lower unemployment,
but only at the cost of higher inflation.
If they contract aggregate demand, theycan lower inflation, but at the cost of
temporarily higher unemployment.
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The Phillips curve illustrates the
short-run relationship between
inflation and unemployment.
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UnemploymentRate (percent)0
InflationRate
(percentper year)
4
B6
A
7
2
Phillips curve
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The greater the aggregate demand for
goods and services, the greater is the
economys output, and the higher is theoverall price level.
A higher level of output results in a lower
level of unemployment.
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Phillips curve
0
(b) The Phillips Curve
Inflation Rate(percent per
year)
UnemploymentRate (percent)
0
(a) The Model of AD and AS
Price Level
Low AD
High AD
B
4
6
(output is8,000)
A
7
2
(output is7,500)
A
7,500
102
(unemploymentis 7%)
B
8,000
106
(unemploymentis 7%)
Short-runAS
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In the 1960s, Friedman and Phelps
concluded that inflation and
unemployment are unrelated in the longrun.
As a result, the long-run Phillips curve is
vertical at the natural rate ofunemployment.
Monetary policy could be effective in the
short run but not in the long run.
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UnemploymentRate
0 Natural rate ofunemployment
InflationRate Long-run
Phillips curve
B
High
inflation1. When theRBI increasesthe growthrate of themoneysupply, the
rate ofinflationincreases
2. but
unemploymentremains at itsnatural ratein the long run.
ALowinflation
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Expected inflation measures
how much people expect the
overall price level to change.
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In the long run,expected inflation adjuststo changes in actual inflation.
The RBIs ability to create unexpected
inflation exists only in the short run.
Once people anticipate inflation, the only
way to get unemployment below the naturalrate is for actual inflation to be above the
anticipated rate.
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UnemploymentRate =
Natural rate ofunemployment
Actual Expected
inflation inflation-
( )a-
This equation relates the unemployment rateto the natural rate of unemployment, actual
inflation, and expected inflation.
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The view that unemployment
eventually returns to its natural rate,
regardless of the rate of inflation, iscalled the natural-rate hypothesis.
Historical observations support the
natural-rate hypothesis.
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In the 1970s, policymakers faced two
choices when OPEC cut output and
raised worldwide prices of petroleum.
Fight the unemployment battle by expanding
aggregate demand and accelerate inflation.
Fight inflation by contracting aggregatedemand and endure even higher
unemployment.
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The theory of rational expectations
suggests that people optimally use allthe information they have, including
information about government policies,
when forecasting the future.
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