This document provides an overview of key concepts related to inflation and unemployment from a macroeconomics textbook. It includes: 1) Definitions of inflation as an increase in the average level of prices and explanations of the relationship between nominal interest rates, real interest rates, and inflation. 2) A model of labor force dynamics that shows unemployment is determined by the rates of job separation and job finding, and how this relates to the natural rate of unemployment. 3) Descriptions of different types of unemployment including frictional, structural, and others, as well as factors that can increase or decrease unemployment rates. 4) An introduction to aggregate supply and demand models and the short-run tradeoff between inflation

1. Chapter Thirteen 1
®
A PowerPointTutorial
To Accompany
MACROECONOMICS, 7th. Edition
N. Gregory Mankiw
Tutorial written by:
Mannig J. Simidian
B.A. in Economics with Distinction, Duke University
M.P.A., Harvard University Kennedy School of Government
M.B.A., Massachusetts Institute of Technology (MIT) Sloan School of Management

2. Chapter Thirteen 22
Inflation

3. Chapter Thirteen 3
Inflation is an increase in the average level of prices, and a price
is the rate at which money is exchanged for a good or service.
Here is a great illustration of the power of inflation:
In 1970, the New York Times cost 15 cents, the median price of a
single-family home was $23,400, and the average wage in
manufacturing was $3.36 per hour. In 2008, the Times cost
$1.50, the price of a home was $183,300, and the average wage
was $19.85 per hour.

4. Chapter Thirteen 4

5. Chapter Thirteen 5
Economists call the interest rate that the bank pays the
Nominal interest rate and the increase in your purchasing power the
real interest rate.
This shows the relationship between the nominal interest rate
and the rate of inflation, where r is real interest rate, i is the
nominal interest rate and p is the rate of inflation, and remember
that p is simply the percentage change of the price level P.
r = i - π

6. Chapter Thirteen 6
The Fisher Equation illuminates the distinction between
the real and nominal rate of interest.
Fisher Equation: i = r + p
Actual (Market)
nominal rate of
interest
Real rate
of interest
Inflation
The one-to-one relationship
between the inflation rate and
the nominal interest rate is
the Fisher effect.
It shows that the nominal interest can change for two reasons: because
the real interest rate changes or because the inflation rate changes.

7. Chapter Thirteen 7
% Change in M + % Change in V = % Change in P + % Change in Y
% Change in M + % Change in V = p + % Change in Y
i = r + p
The quantity theory and the Fisher equation together tell us how money
growth affects the nominal interest rate. According to the quantity
theory, an increase in the rate of money growth of one percent causes a
1% increase in the rate of inflation.
According to the Fisher equation, a 1% increase in the rate of inflation
in turn causes a 1% increase in the nominal interest rates.
Here is the exact link between our two familiar equations: The quantity
equation in percentage change form and the Fisher equation.

8. Chapter Thirteen 8
The real interest rate the borrower and lender expect when a loan is
made is called the ex ante real interest rate. The real interest
rate that is actually realized is called the ex post real interest rate.
Although borrowers and lenders cannot predict future inflation with
certainty, they do have some expectation of the inflation rate. Let p
denote actual future inflation and pe the expectation of future inflation.
The ex ante real interest rate is i - pe, and the ex post real interest rate is
i - p. The two interest rates differ when actual inflation p differs from
expected inflation pe.
How does this distinction modify the Fisher effect? Clearly the nominal
interest rate cannot adjust to actual inflation, because actual inflation
is not known when the nominal interest rate is set. The nominal interest
rate can adjust only to expected inflation. The next slide presents a
more precise version of the the Fisher effect.

9. Chapter Thirteen 9
i = r + Ep
The ex ante real interest rate r is determined by equilibrium in the
market for goods and services, as described by the model in
Chapter 3. The nominal interest rate i moves one-for-one with
changes in expected inflation Ep.

10. Chapter Thirteen 10
The quantity theory (MV = PY) is based on a simple money demand
function: it assumes that the demand for real money balances is
proportional to income. But, we need another determinant of the
quantity of money demanded—the nominal interest rate.
The nominal interest rate is the opportunity cost of holding money:
it is what you give up by holding money instead of bonds. So, the new
general money demand function can be written as:
(M/P)d = L(i, Y)
This equation states that the demand for the liquidity of real money
balances is a function of income (Y) and the nominal interest rate (i).
The higher the level of income Y, the greater the demand for real
money balances.

11. Chapter Thirteen 11
As the quantity theory of money explains, money supply and money
demand together determine the equilibrium price level. Changes in
the price level are, by definition, the rate of inflation. Inflation, in
turn, affects the nominal interest rate through the Fisher effect.
But now, because the nominal interest rate is the cost of holding
money, the nominal interest rate feeds back into the demand for money.
MoneySupply&MoneyDemand
Inflation&theFisherEffect

12. Chapter Thirteen 12
The inconvenience of reducing money
holding is metaphorically called the
shoe-leather cost of inflation, because
walking to the bank more often induces
one’s shoes to wear out more quickly.
When changes in inflation require printing
and distributing new pricing information,
then, these costs are called menu costs.
Another cost is related to tax laws. Often
tax laws do not take into consideration
inflationary effects on income.

13. Chapter Thirteen 13
Unanticipated inflation is unfavorable because it arbitrarily
redistributes wealth among individuals.
For example, it hurts individuals on fixed pensions. Often these
contracts were not created in real terms by being indexed to a
particular measure of the price level.
There is a benefit of inflation—many economists say that some
inflation may make labor markets work better. They say it
“greases the wheels” of labor markets.

14. Chapter Thirteen 14
Hyperinflation is defined as inflation that exceeds 50
percent per month, which is just over 1percent a day.
Costs such as shoe-leather and menu costs are much
worse with hyperinflation—and tax systems are
grossly distorted. Eventually, when costs become too
great with hyperinflation, the money loses its role as
store of value, unit of account and medium of
exchange. Bartering or using commodity money
becomes prevalent.

15. Chapter Thirteen 15
Economists call the separation of the determinants of real
and nominal variables the classical dichotomy. A
simplification of economic theory, it suggests that changes in
the money supply do not influence real variables.
This irrelevance of money for real variables is called
monetary neutrality. For the purpose of studying long-run
issues—monetary neutrality is approximately correct.

16. Chapter Thirteen 1616
Unemployment

17. Chapter Thirteen 1717
Using this notation, the rate
of unemployment is U/L.
Now, we’ll denote the
rate of job separation as s.
Let f denote the rate of job
finding. Together these determine the
rate of unemployment.
The average rate of unemployment around which the economy fluctuates
is called the natural rate of unemployment. The natural rate is the rate
of unemployment toward which the economy gravitates in the
long run. Let’s start with some fundamental equations that will
build a model of labor-force dynamics that shows what
determines the natural rate.
L = E + U
Labor force is composed
of
Number of
employed
workers
Number of
unemployed
workers

18. Chapter Thirteen 1818
f U = s E
Number of people
finding jobs
Number of people
loosing jobs
Steady-state unemployment rate
From an earlier equation, we known that E = L – U, that is the number of
employed equals the labor force minus the number of unemployed. If we
substitute (L-U) for E in the steady-state condition, we find:
f U = s (L – U)
Then, divide both sides by L and to obtain:
f U/L = s (1-U/L)
Now solve for U/L for find :
U/L = s / (s + f)

19. Chapter Thirteen 1919
U/L = s / (s + f)
This can also be written as:
U/L = 1/ (1+ f/s)
This equation shows that the steady-state rate of unemployment
U/L depends on the rates of job separation s and job finding f.

20. Chapter Thirteen 2020
Any policy aimed at lowering the natural rate of unemployment
must either reduce the rate of job separation or increase the rate
of job finding. Similarly, any policy that affects the rate of
job separation or job finding also changes the
natural rate of unemployment.

21. Chapter Thirteen 2121
The unemployment caused by the time it takes workers to search for a
job is called frictional unemployment.
Economists call a change in the composition of demand among
industries or regions a sectoral shift. Because sectoral shifts are
always occurring, and because it takes time for workers to change
sectors, there is always frictional unemployment.
In trying to reduce frictional unemployment, some policies inadvertently
increase the amount of frictional unemployment. One such program is
called unemployment insurance. In this program, workers can collect
a fraction of their wages for a certain period
after losing their job.

22. Chapter Thirteen 2222
Firm takes full
responsibility
for a worker’s
unemployment
Firm takes partial
responsibility for a
worker’
unemployment

23. Chapter Thirteen 2323
Wage rigidity is the failure of
wages to adjust until labor
supply equals labor demand.
The unemployment resulting
from wage rigidity and job
rationing is called structural
unemployment. Workers are
unemployed not because they
can’t find a job that best suits
their skills, but rather, at the
going wage, the supply of labor
exceeds the demand. These
workers are simply waiting for
jobs to become available.
S
D
Labor
Real
wage
U
Rigid
real
wage
If the real wage is stuck above the
equilibrium level, then the supply
of labor exceeds the demand.
Result: unemployment U.

24. Chapter Thirteen 2424
The government causes wage rigidity when it prevents wages from
falling to equilibrium levels.
Many economists and policymakers believe that tax credits are better
than increases in the minimum wage—if the policy goal is to increase the
incomes of the working poor. The earned income
tax credit is an amount that poor working
families are allowed to subtract from the
taxes they owe.

25. Chapter Thirteen 2525
Economists believe that the minimum wage has
the greatest impact on teenage unemployment.
Studies suggest that a 10-percent increase in the
minimum wage reduces teenage employment by
1 to 3 percent.
Teenagers are the least skilled, have the lowest marginal
productivity, and take their compensation in the form of
on-the-job-training, say, at Mankiw’s Burgers. Yum! Speaking of
burgers, about three-fifths of all workers paid the minimum wage or
below are in the food service industry.
M
An apprenticeship is a classic example of
training offered in place of wages.

26. Chapter Thirteen 2626
Another cause of wage rigidity is the monopoly power of unions.
In the United States, only 18 percent of workers belong to unions. Often,
union contracts set wages above the equilibrium level and allow the
firm to decide how many workers to employ. Result: a decrease in the
number of workers hired, a lower rate of job finding, and an increase
in structural unemployment.
The unemployment caused by unions is an instance of conflict between
different groups of workers—insiders and outsiders. In the United
States, this is solved at the firm level through bargaining.

27. Chapter Thirteen 2727
Efficiency-wage theories suggest that high wages make workers more
productive. So, though a wage reduction would lower a firm’s wage
bill, it would also lower worker productivity and the firm’s profits.
The first efficiency-wage theory suggests that wages influence attrition.
A second efficiency-wage theory contends that high wages reduce
labor turnover. A third efficiency-wage theory holds that the average
quality of a firm’s workforce depends on the wage it pays its
employees. A fourth efficiency-wage theory holds that a high wage
improves worker effort.

28. Chapter Thirteen 2828
The natural rate of unemployment has not been stable.
Below 5%
Over 6%
Below 5%

29. Chapter Thirteen 2929
The four largest European countries– France, Germany, Italy, and
the United Kingdom– have experienced high levels of unemployment in
recent years. The cause? No one knows for sure, but here is a leading
theory: Many economists believe that the problem can be traced to the
interaction between a long-standing policy and a recent shock. The
long-standing policy is to have generous benefits for the unemployed.
The recent shock was a technologically driven fall in the demand for
unskilled workers relative to skilled workers.
Did you know that Europeans are more likely to be
unemployed that their American counterparts? Europeans
enjoy shorter workweeks and more frequent holidays.
Also, the employment-to-population ratio is higher in the
U.S. than it is in Europe. Also, Europeans retire earlier than
Americans.

30. Chapter Thirteen 30
Aggregate Supply and the Short-run Tradeoff
Between Inflation and Unemployment
®
A PowerPointTutorial
To Accompany
MACROECONOMICS, 7th. Edition
N. Gregory Mankiw
Tutorial written by:
Mannig J. Simidian
B.A. in Economics with Distinction, Duke University
M.P.A., Harvard University Kennedy School of Government
M.B.A., Massachusetts Institute of Technology (MIT) Sloan School of Management

31. Chapter Thirteen 31
When we introduced the aggregate supply curve of Chapter 9, we
established that aggregate supply behaves differently in the short run
than in the long run. In the long run, prices are flexible, and the
aggregate supply curve is vertical. When the aggregate supply curve is
vertical, shifts in the aggregate demand curve affect the price level, but
the output of the economy remains at its natural rate. By contrast, in
the short run, prices are sticky, and the aggregate supply curve is not
vertical. In this case, shifts in aggregate demand do cause fluctuations
in output. In Chapter 9, we took a simplified view of price stickiness
by drawing the short-run aggregate supply curve as a horizontal line,
representing the extreme situation in which all prices are fixed. So,
now we’ll refine our understanding of short-run aggregate supply to
better reflect the real world in which some prices are sticky and others
are not.

32. Chapter Thirteen 32
After examining the basic theory of the short-run aggregate
supply curve, we establish a key implication. We show that
this curve implies a trade-off between two measures of
economic performance– inflation and unemployment. This
trade-off, called the Phillips curve, tells us that to
reduce the rate of inflation policymakers must
temporarily raise unemployment, and to
reduce unemployment, they must accept
higher inflation. But, this tradeoff is
policymakers face such a tradeoff in the short run and, why
just as importantly, they do not face it in the long run.
Inflation, p
Unemployment, u
only temporary. One goal
of this module is to help
explain how and why

33. Chapter Thirteen 33
Let’s now look into a few prominent models of aggregate supply:
Sticky-price, which is most widely accepted, and an alternative theory
Imperfect-information.
In all the models, some market imperfection causes the output of the
economy to deviate from its natural level. As a result, the
short-run aggregate supply curve is upward sloping, rather than
vertical, and shifts in the aggregate demand curve cause the level of
output to deviate temporarily from its natural level. These temporary
deviations represent the booms and busts of the business cycle.
Although these models takes us down a different theoretical
route, each route ends up in the same place. That final destination is a
short-run aggregate supply equation of the form…

34. Chapter Thirteen 34
Y = Y + a(P-EP) where a > 0
Output
Actual price level
positive constant:
an indicator of
how much
output responds
to unexpected
changes in the
price level.
Natural
rate of output
Expected
price level
This equation states that output deviates from its natural level when the
price level deviates from the expected price level. The parameter a
indicates how much output responds to unexpected changes in the price
level, 1/a is the slope of the aggregate supply curve.

35. Chapter Thirteen 35
Our first explanation for the upward-sloping short-run aggregate supply
curve is called the sticky-price model. This model emphasizes that firms
do not instantly adjust the prices they charge in response to changes in
demand. Sometimes prices are set by long-term contracts between firms
and consumers.
To see how sticky prices can help explain an upward-sloping aggregate
supply curve, first consider the pricing decisions of individual firms
and then aggregate the decisions of many firms to explain the economy
as a whole. We will have to relax the assumption of perfect competition
whereby firms are price-takers. Now they will be price-setters.

36. Chapter Thirteen 36
Consider the pricing decision faced by a typical firm. The firm’s
desired price p depends on two macroeconomic variables:
1) The overall level of prices P. A higher price level implies that the
firm’s costs are higher. Hence, the higher the overall price level, the
more the firm will like to charge for its product.
2) The level of aggregate income Y. A higher level of income raises the
demand for the firm’s product. Because marginal cost increases at
higher levels of production, the greater the demand, the higher the
firm’s desired price.
The firm’s desired price is:
p = P + a(Y-Y)
This equations states that the desired price p depends on the overall
level of prices P and on the level of aggregate demand relative to its
natural rate Y-Y. The parameter a (which is greater than 0) measures
how much the firm’s desired price responds to the level of aggregate
output.

37. Chapter Thirteen 37
Now assume that there are two types of firms. Some have flexible prices:
they always set their prices according to this equation. Others have sticky
prices: they announce their prices in advance based on what they expect
economic conditions to be. Firms with sticky prices set prices according to
p = EP + a(EY - EY)
where the capitalized “E” represents the expected value of a variable. For
simplicity, assume these firms expect output to be at its natural rate, so
the last term a(EY - EY), drops out. Then these firms set price so
that p = EP. That is, firms with sticky prices set their prices based on what
they expect other firms to charge.
We can use the pricing rules of the two groups of firms to derive the
aggregate supply equation. To do this, we find the overall price level in the
economy as the weighted average of the prices set by the two groups.
After some manipulation, the overall price level is:
P = EP + [(1-s)a/s](Y-Y)]

38. Chapter Thirteen 38
The third explanation for the upward slope of the short-run aggregate
supply curve is called the imperfect-information model. Unlike the
sticky-wage model, this model assumes that markets clear—that is, all
wages and prices are free to adjust to balance supply and demand. In this
model, the short-run and long-run aggregate supply curves differ because
of temporary misperceptions about prices.
The imperfect-information model assumes that each supplier in the
economy produces a single good and consumes many goods. Because the
number of goods is so large, suppliers cannot observe all prices at all
times. They monitor the prices of their own goods but not the prices of all
goods they consume. Due to imperfect information, they sometimes
confuse changes in the overall price level with changes in relative prices.
This confusion influences decisions about how much to supply, and it
leads to a positive relationship between the price level and output in the
short run.

39. Chapter Thirteen 39
P = EP + [(1-s)a/s](Y-Y)]
The two terms in this equation are explained as follows:
1) When firms expect a high price level, they expect high costs. Those
firms that fix prices in advance set their prices high. These high prices
cause the other firms to set high prices also. Hence, a high expected price
level E leads to a high actual price level P.
2) When output is high, the demand for goods is high. Those firms
with flexible prices set their prices high, which leads to a high price level.
The effect of output on the price level depends on the proportion of firms
with flexible prices. Hence, the overall price level depends on the
expected price level and on the level of output. Algebraic rearrangement
puts this aggregate pricing equation into a more familiar form:
where a = s/[(1-s)a]. Like the other models, the sticky-price model says
that the deviation of output from the natural rate is positively associated
with the deviation of the price level from the expected price level.
Y = Y + a(P-EP)

40. Chapter Thirteen 40
Let’s consider the decision of a single asparagus farmer, who
earns income from selling asparagus and uses this income to buy
goods and services. The amount of asparagus she chooses to produce
depends on the price of asparagus relative to the prices of other goods
and services in the economy. If the relative price of asparagus is high,
she works hard and produces more asparagus. If the relative price of
asparagus is low, she prefers to work less and produce less asparagus.
The problem is that when the farmer makes her production decision,
she does not know the relative price of asparagus. She knows the
nominal price of asparagus, but not the price of every other good in
the economy. She estimates the relative price of asparagus using her
expectations of the overall price level. See next slide for the equation.

41. Chapter Thirteen 41
If there is a sudden increase in the price level, the farmer
doesn’t know if it is a change in overall prices or just the price
of asparagus. Typically, she will assume that it is a relative
price increase and will therefore increase the production of
asparagus. Most suppliers will tend to make this mistake. To
sum up, the notion that output deviates from its natural level
when the price level deviates from the expected price level is
captured by:
Y = Y + a (P - EP), a > 0
Output Natural level of output Price level
Expected price level

42. Chapter Thirteen 42
Start at point A; the economy is at full employment Y and the
actual price level is P0. Here the actual price level equals the
expected price level. Now let’s suppose we increase the price
level to P1.
Since P (the actual price level) is now greater than Pe (the
expected price level) Y will rise above the natural rate, and we
slide along the SRAS (Pe=P0) curve to A' .
Remember that our new SRAS (Pe=P0) curve is defined by the
presence of fixed expectations (in this case at P0). So in terms
of the SRAS equation, when P rises to P1, holding Pe constant
at P0, Y must rise.
The “long-run” will be defined when the expected price level equals the actual price level. So, as price level
expectations adjust, EPP2, we’ll end up on a new short-run aggregate supply curve, SRAS (EP=P2) at point
B.
Hooray! We made it back to LRAS, a situation characterized by perfect information where the actual price
level (now P2) equals the expected price level (also, P2).
Y = Y + a (P-EP)
Y = Y + a (P-EP)
Y = Y + a (P-EP)
In terms of the SRAS equation, we can see that as EP catches up with P, that entire “expectations gap”
disappears and we end up on the long run aggregate supply curve at full employment where Y = Y.
SRAS (EP=P2)
BP2
A'
Y'
SRAS (EP=P0)
P
Output
AP0
LRAS*
Y
AD
AD'
P1

43. Chapter Thirteen 43
The Phillips curve in its modern form states that the inflation rate
depends on three forces:
1) Expected inflation
2) The deviation of unemployment from the natural rate, called
cyclical unemployment
3) Supply shocks
These three forces are expressed in the following equation:
p = Ep - b(m-mn) + n
Inflation b  Cyclical
unemployment
Supply
shocks
Expected
inflation

44. Chapter Thirteen 44
The Phillips-curve equation and the short-run aggregate supply equation
represent essentially the same macroeconomic ideas. Both equations
show a link between real and nominal variables that causes the
classical dichotomy (the theoretical separation of real and nominal
variables) to break down in the short run.
The Phillips curve and the aggregate supply curve are two sides of the
same coin. The aggregate supply curve is more convenient when
studying output and the price level, whereas the Phillips curve
is more convenient when studying unemployment and inflation.

45. Chapter Thirteen 45
To make the Phillips curve useful for analyzing the choices facing
policymakers, we need to say what determines expected inflation. A
simple often plausible assumption is that people form their expectations
of inflation based on recently observed inflation. This assumption is
called adaptive expectations. So, expected inflation Ep equals last year’s
inflation p-1. In this case, we can write the Phillips curve as:
which states that inflation depends on past inflation, cyclical
unemployment, and a supply shock. When the Phillips curve is written in
this form, it is sometimes called the Non-Accelerating Inflation Rate of
Unemployment, or NAIRU.
The term p-1 implies that inflation has inertia—it keeps going
until something acts to stop it. In the model of AD/AS, inflation inertia
is interpreted as persistent upward shifts in both the aggregate supply
curve and aggregate demand curve. Because the position of the SRAS
will shift upward overtime, it will continue to shift upward until
something changes inflation expectations.
p = p-1 - b(m-mn) + n

46. Chapter Thirteen 46
The second and third terms in the Phillips-curve equation show the two
forces that can change the rate of inflation. The second term, b(u-un),
shows that cyclical unemployment exerts downward pressure on inflation.
Low unemployment pulls the inflation rate up. This is called
demand-pull inflation because high aggregate demand is responsible for
this type of inflation. High unemployment pulls the inflation rate down.
The parameter b measures how responsive inflation is to cyclical
unemployment. The third term, n shows that inflation also rises and falls
because of supply shocks. An adverse supply shock, such as the rise in
world oil prices in the 70s, implies a positive value of n and causes
inflation to rise.
This is called cost-push inflation because adverse supply shocks are
typically events that push up the costs of production. A beneficial
supply shock, such as the oil glut that led to a fall in oil prices in the
80s, makes n negative and causes inflation to fall.

47. Chapter Thirteen 47
un
Inflation, p
Unemployment, u
Ep + n
In the short run, inflation and unemployment
are negatively related. At any point in time, a
policymaker who controls aggregate demand
can choose a combination of inflation and
unemployment on this short-run Phillips
curve.

48. Chapter Thirteen 48
un

Unemployment, u
LRPC (u=un)
5%
10%
SRPC (E = 0%)
SRPC (E = 10%)
SRPC (E = 5%)
D
B C
E
Suppose there is an increase in the rate of growth of the money supply causing LM and AD to shift out,
resulting in an unexpected increase in inflation. The Phillips curve equation  = E – b(u-un) + v
implies that the change in inflation misperceptions causes unemployment to decline. So, the economy
moves to a point above full employment at point B.
A
As long as this inflation misperception exists, the economy will
remain below its natural rate un at u'.
Let’s start at point A, a point of price stability ( = 0%) and full employment (u = un).
When the economic agents realize the new level of inflation, they
will end up on a new short-run Phillips curve where expected
inflation equals the new rate of inflation (5%) at point C, where
actual inflation (5%) equals expected inflation (5%).
Remember, each short-run Phillips curve is defined by the presence of fixed expectations.
If the monetary authorities opt to obtain a lower u again,
then they will increase the money supply such that  is 10
percent, for example. The economy moves to point D,
where actual inflation is 10%, but, E is 5%p.
When expectations adjust, the
economy will land on a new SRPC, at
point E, where both  and E equal
10 percent.
u'

49. Chapter Thirteen 49
Rational expectations make the assumption that people optimally use all
the available information about current government policies, to forecast
the future. According to this theory, a change in monetary or fiscal
policy will change expectations, and an evaluation of any policy change
must incorporate this effect on expectations. If people do form their
expectations rationally, then inflation may have less inertia than it first
appears.
Proponents of rational expectations argue that the short-run Phillips
curve does not accurately represent the options that policymakers have
available. They believe that if policy makers are credibly committed to
reducing inflation, rational people will understand the commitment and
lower their expectations of inflation. Inflation can then come down
without a rise in unemployment and fall in output.

50. Chapter Thirteen 50
Our entire discussion has been based on the natural rate hypothesis.
The hypothesis is summarized in the following statement:
Fluctuations in aggregate demand affect output and employment only
in the short run. In the long run, the economy returns to the levels of
output,employment, and unemployment described by the classical model.
Recently, some economists have challenged the natural-rate hypothesis
by suggesting that aggregate demand may affect output and employment
even in the long run. They have pointed out a number of mechanisms
through which recessions might leave permanent scars on the economy
by altering the natural rate of unemployment. Hyteresis is the term
used to describe the long-lasting influence of history on the natural
rate.