Unit 5 Notes

Relating Phillips Curve to AS/AD

• Changes in the AS/Ad model can also be seen in the Phillips Curves
• Almost like mirror images
• Two models are not equivalent. The AS/AD model is static but the Philips Curve includes changes over time, while the 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 .

Stagflation: rising inflation and rising unemployment

• Civil right movement
• Women's movement
• Baby boom 1946 1964
• When Vietnam ended
• Embargo 1973 - 1979

Disinflation

• Reduction in inflation rate from year to yer which is usually displayed in the LRPC
• This occurs when AD declines
• In short run profits fall and the unemployment rate increases

Deflation

• Actual drop in the price level

Laffer Curve

Supply side economics

• Supply side economist tend to believe that the AS curve will determine levels of inflation, unemployment and economic growth
• To increase the economy, you take action to shift the AS curve to the right, always benefitting the company first. 
• Focus on marginal tax rate ( amount paid on the last dollar earned or on each additional dollar)
• Reduction in marginal tax rate, you encourage more people to work longer in which they would for go their leisure time for extra income.
• 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 in business investments.
• Reaganomics: lowered marginal tax rate to get US out of recession and caused a deficit.

Laffer Curve

It is a trade off between tax rates and goverment revenue 

Used to support the supply side argument

As tax rates increase from 0, tax revenues increase from 0 to some maximum level and then decline.

Criticisms of the Laffer Curve 

Research suggests that the impact on tax rates on incentives to work, save and invest are small.

Tax cuts also increase demand which can fuel inflation which will cause demand to exceed supply.

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