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The Basic Macro Framework Notes
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THE BASIC MACRO FRAMEWORK 'Macroeconomics: Imperfections, institutions and policies' Carlin & Soskice 2006 (Ch 1- 4) CHAPTER 1
The 3-equation model (IS, PC and MR) o Assumptions
Short run - output and employment can change but before prices and wages respond to the changes in output and employment
i.e. can assume that wages and prices are given in the short run
Medium run - wages and prices respond to changes in output and employment and supply side of the economy adjusts to establish a medium run equilibrium in which inflation is constant
Continue to assume that capital stock and labour force are fixed
Medium run analysis therefore focused on the behaviour of wage and price setters. o Fluctuations in output and employment
'one concern of macroeconomists is with the causes and consequences of short run fluctuations in economic activity.'
'booms with strong growth of output and recessions with sharp contractions are evident: the swing from peak to trough and back again is called the business cycle.'
If we assume prices and wages are given in the short run, so we can concentrate on how quantities (i.e. output and employment) adjust to changes in the demand for goods and services. o Unemployment
Trend of rising u/e from the 1970s to the 1990s in Europe
Idea of a roughly constant equilibrium u/e rate looks more plausible for the US than for Europe - in the US, u/e fluctuates a lot but it appears to have fluctuated around a rate of about 6% since the 1960s
UK o Followed the same trend rise in u/e as much of Europe from the early 1970s to the early 1980s o Since then, there has been a downward trend that was interrupted but not halted by the recession of the early 1990s
Seems that changes in unemployment persist over time, and big differences across countries o 'they motivate the notion of a medium run unemployment rate, in which changes over time and differences across countries are associated with variations in supply side structure.'
Modelling medium run unemployment
Only kind of u/e that exists in the competitive equilibrium is voluntary u/e - 'competitive equilibrium rate of unemployment'
Imperfect competition model o Can be involuntary u/e even at equilibrium o Introduce wage setters and price setters
Firms can earn supernormal profits
'The real wage for an individual will depend both on the outcome of wage setting and on the outcome of price setting across the economy.'
One level of employment and rate of u/e at which both wage and price setters accept the prevailing real wage - 'imperfectly competitive equilibrium rate of unemployment' o Inflation
Economy initially at medium run equilibrium - therefore equilibrium rate of u/e (ERU), no pressure for WS or PS to adjust and inflation is therefore constant
Increase in AD o Output and employment rise in the short run and u/e therefore
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