Please enable JavaScript.
Coggle requires JavaScript to display documents.
24.2 The Adjustment Process - Coggle Diagram
24.2 The Adjustment Process
Potential Output and Output Gap
Potential Output
Caused by increases in factor supply and productivity and technological change
is not maximum output of an economy
realizable total output when all factors used at normal utilization rate
Output Gap = Y - Y*
; Y-Y
/Y
x100
RELATIONSHIP among OUTPUT GAPS, FACTOR MARKETS and FACTOR PRICES
Factor Prices and Output Gap
Key Assumptions
1) when real GDP is above potential output, there will be pressure on factor prices to rise because of a higher than normal demand for factor inputs
2) when real GDP is below potential output, there will be pressure on factor prices to fall because of a lower than normal demand for factor inputs
Output Above Potential, Y > Y*; BOOMS
1) Firms producing beyond capacity → excess demand for all factor inputs → unit costs rising → wages rising (avoid strikes, workers leaving)
2) increase in unit costs require higher prices in order to supply any given level of output → AS curve shifts up → P increasing and real GDP reduced
3) Once AS curve shifts back to Y*, inflationary gap disappears
Output Below Potential, Y < Y*; SLUMPS
1) Firms producing below capacity → excess supply of factors (from what was previously in Y*) → unit costs reduced → wages fall
2) as unit costs fall, firms require lower price any given level of output → AS curve shifts down → to P decreasing and GDP increasing
Downward Wage Stickiness
Downward shift in AS curve and downward pressure on P are quite weak
Potential Output as an "Anchor"
Output gap is assumed to cause wages and other factor prices to adjust, eventually bringing Ye of output back to Y*
Output Gap → Wage Adjustment (SRAS reaction) → Y returns to Y*
SRAS is the "chain"
(uses wage adjustment to "pull" Y back to Y
; Y
acts as the "anchor
The Phillips Curve
rate of change of wages inversely related to u-rate
; high u-rate = wages falling (working for less to find a job) and low u-rate = wages high (attracting workers)