44. The Phillips curve.

Shows a stable relationship between the rate of inflation and the unemployment rate.

This curve is available for short-run period. In the long-run the economy automatically gravitates to its natural rate of unemployment. The Philips curve is vertical.

45. The adaptive and rational expectations theories.

The adaptive expectations theory

• Assumes people form their expectations of future inflation on the basis of previous and present rates of inflation. When people do, the U rate return to the natural rate.

• The long-run Phillips Curve is therefore vertical.

The rational expectations theory

• Assumes that increases in nominal wages lag behind increases in the price level because the increases in the price level are not anticipated.

• Workers will anticipate the inflationary effects of monetary and fiscal policy and will build these expectations into their wage demands.

• As a result, not even a short-run Phillips curve will exist.

• The economy will simply move along its vertical long-run Phillips Curve when government undertakes expansionary policies.

46. Supply – side economics. Laffer curve.

Changes in AS must be recognized as active forces in determining the levels of both inflation and unemployment.

Tax- Transfer disincentive.

The growth of tax-transfer system has negatively affected incentives to work, invest, innovate.

Supply-side economists believe.

 How long and how hard individuals work depends on how much additional after-tax earnings they derive from work

 So, government should reduce marginal tax rates on earned incomes.

 The existence of a wide variety of public transfer programs has eroded incentives to work

 Lower marginal tax rates encourage saving and investing

Laffer Curve

The main idea: Lower tax rates are compatible with constant or even engaged tax revenues.

Up to “max”-large tax revenue,

Then-tax revenues will decline.

 Tax rates can be lowered without producing budget deficits for two reasons:

-Less tax evasion. It declines when are reduced

-Reduced transfers

47. International trade. Comparative advantage.

The principle of comparative advantages: Total output will be greatest when each good is produced by that nation which has the lowest domestic opportunity cost for that good.

Comparative advantage: Suppose the word economy is composed of just 2 nations: Russia and Brazil. The “word” clearly is not economizing in the use of its resources, if a specific product is produced by high-cost producer, when it could have been produced by low-cost producer.

Specialization according to comparative advantage results in:

• a more efficient allocation of word resources

• larger outputs of both products and therefore available to both nations