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Principles of economics openstax chapter26

# Chapter Title
Chapter 26
The Neoclassical
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The great recession

The impact of the Great Recession can be seen in many areas of the economy that impact our daily
lives. One of the most visible signs can be seen in the housing market where many homes and
other buildings are abandoned, including ones that midway through construction.

The gdp gap

Actual GDP falls below potential GDP during and after recessions, like the recessions of 1980 and 1981–82, 1990–91,
2001, and 2008–09 and continues below potential GDP through 2012. In other cases, actual GDP can be above
potential GDP for a time, as in the late 1990s.

The Neoclassical View:
Wage & Price Flexibility

The labor market is brought to equilibrium by rising and falling wage rates.
There should not be any persistent unemployment above the natural rate.

The Neoclassical View:
Wage & Price Flexibility

In a recession, when the demand for labor declines,
the equilibrium wage will fall.
Any unemployed worker who wants a job will have
one, but at lower wage rate.
So, the market arrives at a new equilibrium with a
lower wage rate and reduced employment.

In this model, unemployment is voluntary as some workers choose not to get jobs at lower wages.

The Neoclassical View:
Wage & Price Flexibility

The neoclassical idea that wages adjust to clear the labor market is
consistent with the view that wages respond quickly to price changes.
This means that the economy stabilizes at full-employment GDP and the longrun AS is a vertical line. Therefore, monetary and fiscal policy cannot affect
the level of output and employment in the long-run.

The long-run aggregate supply

In the neoclassical model, AS is is a vertical line at potential GDP. Hence, only AS determines the level of output,
no matter where AD is located. Over time, the AS curve shifts to the right as productivity increases and potential
GDP expands.

The acceleration hypothesis

In the long-run, the economy stabilizes at potential GDP. An expansion of the AD will be just inflationary.

The acceleration hypothesis

As AD increases, output grows beyond potential GDP and price level rises. Workers adjust their expectations for price
inflation to get wage increases. SRAS declines moving back the economy to potential GDP, but higher prices.

Long-run Phillips curve

A vertical line AS at potential GDP indicates a vertical Phillips Curve at the natural unemployment rate.

Effect of stabilization policy

As aggregate demand shifts to the right, the GDP and unemployment do not change. However, there
is inflationary pressure for a higher price level as the equilibrium changes from E 0 to E1 to E2.

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