Supply Side Economics

-Supply Side Economics (Reaganomics)

• Supply side economists tend to believe the ASA curve will determine levels of inflation, unemployment, and economic growth.
• To increase the economy, you take actions to shift the AS curve to the right. 
• Always benefitting the company first. 
• They focus on marginal tax rates, which is the amount paid on the last dollar earned or on each additional dollar.
• Lowered taxes are an incentive for businesses to invest in our economy. 
• Lowered taxes are incentives for people to increase savings and therefore create lower interest rates for increases and business investment. 
• They only believe in AS. 

• The laffer curve is a trade off between tax rates and government revenue 
• It is used to support the supply side argument 
• As tax rates increase from zero, tax revenues increase from zero to some maximum level and then decline. 

-Criticisms of the Laffer Curve: 

-Research suggest that the impact of tax rates of incentives to work save and invest are small.

-Tax cuts also create demand. Which will cause demand to exceed supply. 

-Where the economy is actually located on the curve is difficult to determine. 

-Reaganomics:

-lowered the marginal tax rates to get the US out of a recession led to a deficit. 

Long Run Phillips Curve

-The Long Run Phillips Curve (LRPC) 

•because the long run Phillips curve exists at the natural rate of unemployment, structural changes in the economy that affect unemployment will also cause the LRPC to shift.

•increases in unemployment will shift LRPC>

•decreases in unemployment will shift LRPC< 

•Changes in the AS/AD model can also be seen in the Phillips curves 

•an easy way to understand how changes in the AS/AD model affect the Phillips curve is to think of the two sets of graphs as mirror images 

•NOTE: the 2 models are not equivalent. The AS/AD model is static, but the Phillips curve includes change over time. Whereas AS/AD shows one time changes in the price level as inflation or deflation, the Phillips curve illustrates continuous change in the price level as either increased inflation or disinflation. 

Periods of Stagflation:

•civil rights movement 

•women's movement 

•baby boom error

•Vietnam ended 

• all embargo (1973 and 1979)

•Disinflation: reduction in the inflation rate from year to year. 

•This also occurs when aggregate demand declines.

•In the short run, profits fall and the unemployment rate increases.

•Deflation: an actual drop in the price level. 

Phillips Curve

Phillips Curve: Relationship between unemployment and inflation.

The trade off between unemployment and inflation is on the short run. 

SHORT RUN PHILLIPS CURVE:

•It has relevance to Okun's law. For every 1% percent of unemployment, there is a 2% 

•There is an inverse relationship between unemployment rates and inflation rates. 

• Since wages are sticky, inflation changes. Move the points on the SRPC. 

•If inflation persists and the expected rate of inflation rises, then the entire SRPC moves upward. Which creates a situation called "stagflation".

•STAGFLATION: You have high unemployment plus high inflation simultaneously. 

•If inflation expectations stop due to new technology, then the SRPC will move downward. 

LONG RUN PHILLIPS CURVE: 

•It occurs at the natural rate of unemployment.

• It is represented by a vertical line. 

•There is no trade off between unemployment and inflation in the long run. •It only shifts if the LRAS curve shifts. 

• The major LRPC assumption is that more worker benefits create higher natural rates and fewer worker benefit create lower natural rates. 

•If LRAS is stable, so is LRPC.

Natural Rate of Unemployment: Seasonal, structural, and Frictional. Cyclical does not count because 

•Aggregate supply shocks can cause the rate of inflation and the rate of unemployment to increase. 

-What are Supply Shocks? 

•They are rapid and significant increases in resource cost which will cause the SRAS curve to shift. 

-The Misery Index: 

•A combination of inflation and unemployment in a given year.

• Single digit misery is good. 

Unit 4 video