MACRO: CH. 14

Explain Cost-Push Inflation.

Cost-Push Inflation is when an Adverse Supply Shock causes inflation to rise. It is so-called because an Adverse Supply Shock will push up the cost of production.

Explain Demand-Pull Inflation.

Demand-Pull Inflation is when a decrease in cyclical unemployment (with more people than normal employed) pulls the inflation rate up. High Aggregate Demand is responsible for this kind of inflation.

Define Hysteresis.

Hysteresis is the term used to describe the long-lasting influence of history on the natural rate.

Explain the assumption of Rational Expectations.

It is the assumption that people optimally use all available information to forecast the future and gauge expectations of inflation. Because of this, a change in monetary or fiscal policy will change expectations-- so evaluation of any policy change must incorporate this effect.

What is Adaptive Expectation?

It is the simple yet plausible assumption that people form their expectations of inflation based on recently observed inflation.

What is the Imperfect-Information Model?

The Imperfect-Information Model is another explanation for an upward-sloping SRAS. Unlike the Sticky-Price Model, it assumes markets clear. It argues that the SRAS and LRAS curves differ due to TEMPORARY MISPERCEPTIONS ABOUT PRICES. (Asparagus Farmer example-- knows Asparagus market well, but not price of asparagus relative to other goods in the economy). Basically, it says that when ACTUAL PRICES EXCEED EXPECTED PRICES, suppliers raise their output.

Explain the Natural-Rate Hypothesis.

The Natural-Rate Hypothesis states fluctuations in Aggregate Demand (AD) only have short-run effects on output and unemployment, as in the long run the economy returns to the levels of output & employment described by the Classical Model.

What is the Phillips Curve? What does it tell us regarding policy?

The Phillips Curve is a more nuanced representation of the SRAS Curve, reflecting the tradeoff between inflation and unemployment. It basically says that the inflation rate depends on three forces: EXPECTED INFLATION, CYCLICAL UNEMPLOYMENT, and SUPPLY SHOCKS. It tells us that to reduce inflation policymakers must temporarily increase unemployment. Similarly, to reduce unemployment, they must accept inflation. ("output rises above its natural level when the price level exceed the expected price level.") **THIS TRADEOFF ONLY EXISTS IN THE SHORT RUN, NOT IN THE LONG RUN.

What is the Sacrifice Ratio?

The Sacrifice Ratio is the percentage of a year's real GDP that must be forgone to reduce inflation by 1 percent. (The typical estimate is 1% fall inflation:5% sacrifice of one year's GDP)

What is the Sticky-Price Model?

The Sticky-Price Model is just one explanation for an upward-sloping SRAS. It argues that firms do not instantly adjust the prices they charge in respond to changes in demand. This can be due in part to past contracts with customers, firms not wanting to annoy customers with inconsistent prices, sticky wages, and the cost of altering catalogs/price lists.