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Example: Perm increase in G, no policy intervention. Notes:. IS and AD moves right, increase in G Y goes up in short term (only by G. I goes down and C stays put). Because r goes up, we “entice” firms to keep producing by increasing P. - shifts LM left, raising r even more
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Example: Perm increase in G, no policy intervention Notes: IS and AD moves right, increase in G Y goes up in short term (only by G. I goes down and C stays put) Because r goes up, we “entice” firms to keep producing by increasing P. - shifts LM left, raising r even more - shifts labor supply down Nd Self-correcting action: People get upset About working more and getting paid less So wages go up. When wages go back up, SRAS moves left, which raises prices again. This Moves LM left again, which raises r again. This crowds out investment. %ΔP = %ΔW |ΔI|=|ΔG| Short Run 0 0 0 0 0 0 0 0 Long Run 0 0 0 0 0 0 0 0 0
