Aggregate Supply in SR & Phillips Curve

Aggregate Supply in SR & Phillips Curve

1. Y=Ybar + alpha(P-EP)

   • Upward sloping in SR

2. Sticky-Price Model

   • Firms set own flexible price, p
     • p = P + alpha(Y-Ybar)
   • Firms w/ sticky price, set before they know P & Y
     • p = EP + alpha(EP-EYbar)
       • Expect Y=Ybar => p=EP
   • s= fraction sticky price firms. 1-s=fraction flexible price firms
     • P = s[EP] + (1-s)[P+alpha(Y-Ybar)]
       • P = EP + [(1-s)alpha/s](Y-Ybar)
         • Y= Ybar + alpha(P-EP)

3. Imperfect Information Model

   • Determine good relative price: Pown/Poverall
   • Poverall Increase
     • Expected increase so P=EP => doesn't produce more
     • Didn't Expect P increase => Produce more because P>EP

4. Phillips Curve: pi = Epi - beta(u-un)+v

   • Adaptive Expectations
     • Epi = last years inflation
     • Inflation Inertia
       • Cost-Push Inflation
         • From supply Shocks
       • Demand-Pull Inflation
         • From demand shocks
   • downward sloping
   • Sacrifice Ratio = GDP Loss/Inflation Reduction
     • Use Okun's Law = 1% u = 2% lost output
   • Rational Expectations
   • Natural-Rate Hypothesis
     • Hysteresis