Intermediate
Macroeconomics
Lecture 9
Questions from Last Lecture
? Demand for money ↑
D ↑while S fixed
? L(r,Y),hold r &↓Y to balance the
pressure of D ↑; hold Y,↑r to balance
(,)
sdM M M
L r YPP
P
?
?
? ? ? ?? ? ?
? ? ? ?? ? ? ?
r
Y
LM
IS
IS-LM as a Theory of Aggregate Demand
?IS-LM model shows the relationship
between r and Y at a given price level
?What if P changes?
P↑? (M/P)↓
M/P2
P2
AD
r
M/P
L(r,Y)
M/P1
Y
r
IS
LM
P1
P
Y
IS-LM as a Theory of Aggregate Demand
?Change in monetary policy
r
Y
IS
LM
AD
Y
P
IS-LM as a Theory of Aggregate Demand
?Change in Fiscal Policy
r
Y
IS
LM
AD
Y
P
Aggregate Supply
?4 models of AS
?Inflation,unemployment & the Philips
curve
?New Keynesian economics
4 Models of AS
1,The sticky-wage model
P↑
? real wage (W/P)↓
? labor employment↑
? Y ↑
L
W/P
L
Y
Y
P AS
4 Models of AS
?Two parties set the nominal wage based on
target real wage and their expected price level
eWWPP ??
ePW ?? ?
)/(/ PPPW e?? ?
WP L Y
P ??? ? ? ?? ?
4 Models of AS
2,The worker-misperception model
Wages are free to equilibrate S & D
However,
Workers temporarily confuse real and
nominal wage (or workers do not know
what the true price level is so that they
have no idea of what the real wage is)
4 Models of AS
?Labor S and labor D now based on different real
wage rates
)/( PWLL dd ?
)/( ess PWLL ?
4 Models of AS
?If the expected P is the same as actual P,labor
D and labor S base on the same real wage ?
no change on labor market (market clear)
?If P↑ but workers don’t know
P
W
P
W
e ?
*S WL L YP? ? ? ? ? ? ?
4 Models of AS
?Both models predict that real wage and
output is countercyclical,
Ch a n g e i n Real Wage and Change in Real GDP per
capita (China)
0
20
40
60
80
100
120
140
1
9
8
5
1
9
8
7
1
9
8
9
1
9
9
1
1
9
9
3
1
9
9
5
1
9
9
7
1
9
9
9
2
0
0
1
real wage
real GDP
4 Models for AS
3,The imperfect-information model
What matters is the relative price,But individuals
only know the price of their own good
(nominal price),not the overall price level
(have no idea of the relative price)
)( ePPYY ???
?
?
4 Models of AS
4,The sticky-price model
Firms’ desired price )( ???? YYaPp
)(
?
??? eee YYaPp
e e eY Y p P
?
? ? ?
)]()[1( ?????? YYaPssPP e
)(
)1(
ePP
as
sYY ?
?
??
?
( 1 ) ()e saP P Y Y
s
??
? ? ?
4 Models of AS
Labor Goods
Yes
No
Markets clear?
(w or p free)
Market with imperfection
Sticky-wage model Sticky-price model
Worker-misperception model
Imperfect-information model
4 Models of AS
?Shifts in AD
B
P
AD
AS
A
Y
SR
SR
C
LR
LRAS
Exercise
? Consider the following changes in the
sticky-wage model,
a,Suppose that labor contracts specify that
the nominal wage be fully indexed for
inflation,i.e,the nominal wage is to be
adjusted to fully compensate for changes
in the CPI,How does this full indexation
alter the AS curve?
Answer
Sticky-wage model
Two parties set the nominal wage based on target
real wage and their expected price level
P↑
? real wage (W/P)↓
? labor employment↑
? Y ↑
ePW ?? ?
Answer
a,Full indexing
ePW ?? ?
WP???
W
P
? ?
:A S Y Y??
Exercise
b,Suppose now that indexation is only
partial,i.e,for every increase in the CPI,
the nominal wage rises,but by a smaller
percentage,How does this partial
indexation alter the AS?
Answer
b,Partial indexing
Unexpected P ↑
? target real wage > real wage
? L ↑
? Y ↑
AS no longer vertical,but will be steeper
than without indexing
Answer
L
W/P
L
Y
Y
P AS