Inflation, unemployment, Business CycleMicroeconomic FoundationAlaleh Mani2011

Quick Review

Real GDP

Inflati

on,

Pri

ce level, G

DP d

eflato

r

LAS0

LAS0

1.TechnologyEconomic Growth: 2.Capital Accumulation 3. Labor Growth

Inflation: AD:AD Speed up Potential GDP, Quantity of moneyASA: Oil PriceExpectation: E(Inflation) push AD right

Business

Cycle

Inflation Three different monetary phenomenon cause inflation: 1.Demand Pull Inflation:

1. Interest rate Fall Investment Rise( CFA EXAM 2009)2. Tax Fall Consumption and Investment Rise3. Quantity of Money rise interest rate fall investment rise4. Export rise5. Import Fall

2.Cost push Inflation:6. 1.Money wage rate increase7. 2.Natural resource price rise

3.Expectation of InflationIt is a theory of quantity of Money: Consumption will rise due to

expectation AD rise

Cost of Factor of production rise

Demand Pull Inflation1. Interest rate Fall Investment Rise( CFA EXAM 2009)2. Tax Fall Consumption and Investment Rise3. Quantity of Money rise(Fed Buy back bond) (exam 2009) interest

rate fall investment rise4. Export rise5. Import Fall

Unemployment<Natural

Money wage rate :

Supply cost rise

One time rise in the price level does not mean inflation

Demand Pull rise process

Cost Push Inflation1. Money wage rate increase2. Natural resource price rise

One time rise in the price level does not mean inflation

Unemployment>Natural

Fed cuts Tax to calm down the outrageAnd fight against STAGFLATION

Cost Push Rise process

Expected Inflation In expect of rise of AD, money wage rise at same pace If expectation is based on relevant information it is

rational expectation

Phillips Curve To simplify the AS AD movement To depict short run inflation To see actual inflation and E(inflation) The relation between unemployment and

inflation AS talks about price level(inflation) and

GDP(labor force production)Phillips curve derive from AS

E(inflation rate) and natural unemployment=constant

SRPC

Unemployment < natural unemployment rate

Unemployment > natural unemployment rate

LRPCExp

ecta

tion

ch

an

ge

PC movement

Increase in natural UNEMPLOYMENT: labor population The whole system moves

natu

ral u

nem

plo

ym

en

t 1

natu

ral u

nem

plo

ym

en

t 2

Expectation =fix

Business Cycle

Real GDP

Inflati

on,

Pri

ce level, G

DP d

eflato

r

LAS0LAS0

Economic Growth and EXPANSION:

Mainstream Business cycle theory

Different speed cause fluctuation in AD

lead to Business Cycle

AD

AD

AD

Business Cycle Keynesian: AD moved by Investor confidence Monetarist: AD moved by Quantity of money New classical: AD moved by expectation of inflation New Keynesian: Consider money wage rate on SAS

movement as well Real Business Cycle: R&D Pulse in new technology Productivity after a

lag LAS growsLag caused by low skilled worker that need time to

adapt with technology this lag make a reverse movement of AD and AS at fist and cause cycles