V. Pedagogy

1. Points of Clarification

The introduction of the expected price level, even in the simple fashion of the text, is a big jump for students. The text quickly removes the expected price level from discussion by equating it with the actual price level. As a result, students begin to think of the wage-setting and price-setting diagram as the method to determine unemployment at any time. It is worthwhile to emphasize that the natural rate is a medium-run concept and that there is no presumption that the price level equals the expected price level, or that the unemployment rate equals the natural rate, in the short run.

2. Alternative Sequencing

The second and third editions of the text move directly from IS-LM to aggregate demand and aggregate supply. The first edition took up expectations after introducing IS-LM and then expanded the IS-LM framework to the open economy. The material in the third edition still allows instructors the option of considering expectations, the open economy in the short run, or both, before moving to aggregate demand and aggregate supply.

VI. Extensions

1. The Concept of the Medium Run

It may be worthwhile to reexamine the concept of the medium run in this chapter. Typically, disturbances are analyzed in the text as follows. Assume the economy begins in a medium-run equilibrium. Now consider an economic disturbance. The new medium-run equilibrium describes a point to which the economy will tend to return in the absence of further disturbances. The new short-run equilibrium describes the immediate effect of the disturbance. This chapter describes the effects of disturbances on the unemployment rate and output in the medium run. Chapter 7 describes the short-run effects of economic disturbances and the transition from the short-run to the medium-run equilibrium. In the process, Chapter 7 describes the adjustment of prices over the medium run. In the real world, the economy is always experiencing some short-run shock and responding to previous shocks, so it is rarely in medium-run equilibrium. The medium-run concept is an analytical tool.

2. Additional Examples

Additional examples are presented in boxes in later chapters on the labor market. Some of these examples could be introduced here. In Chapter 8, which examines the Phillips curve, boxes examine the Japanese unemployment rate and changes in the U.S. natural rate over time. Although these examples fit naturally into a discussion of the history of the Phillips curve, instructors could use these examples in this chapter to reinforce the idea the natural rate of unemployment actually depends on structural factors that can change. In Chapter 13, a box discusses European unemployment. Instructors could also introduce this example in this chapter, but with care, since the discussion of European unemployment is related to technological change, the topic of Chapter 13.

VII. Observations

The real wage is unaffected by the business cycle in the model of this chapter. Given the labor only, constant returns to scale production function, the real wage is always determined by the price-setting relation, regardless of whether P=P^e. Thus, the real wage is always determined by the degree of competition in product markets and the marginal product of labor (set equal to one in this chapter). Assuming that market structure changes relatively slowly, the implication of this model is that the real wage changes only when labor productivity changes.

1 The text provides evidence about job separations, which include quits as well layoffs. However, a note argues that quits are lower when the unemployment rate is high – as we would expect from theory – so that layoffs actually increase by more than separations when the unemployment rate is high.

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