Lucas aggregate supply function: Difference between revisions

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New classical made its first attempt to model aggregate supply in Lucas and [[Leonard Rapping]] (1969).<ref>{{Cite journal | doi = 10.2307/1808963| jstor = 1808963| doi_brokendate = 2015-04-10|title=Price Expectations and the Phillips Curve|author1=Robert E. Lucas, Jr.|author2= Leonard A. Rapping|journal=The American Economic Review|volume=59|number= 3|date=June 1969|pages= 342–350|publisher= American Economic Association}}</ref> In this earlier model, supply (specifically labor supply) is a direct function of real wages: More work will be done when real wages are high and less when they are low. Under this model, unemployment is "voluntary."<ref name="SnowdonVane233">Snowdon and Vane (2005), 233.</ref> In 1972 Lucas made a second attempt at modelling aggregate supply.<ref name="SnowdonVane233" /> This attempt drew from [[Milton Friedman]]'s [[natural rate hypothesis]] that challenged the Phillips curve.<ref name="SnowdonVane453">Snowdon and Vane (2003), 453.</ref> Lucas supported his original, theoretical paper that outlined the surprise based supply curve with an empirical paper that demonstrated that countries with a history of stable price levels exhibit larger effects in response to monetary policy than countries where prices have been volatile.<ref name="SnowdonVane453" />

On the basis of Lucas’ 1973 paper, Sargent and Wallace intruduced their ’surprise’ supply function in which there was a white noise error term introduced that cannot be predicted in any way. Lucas introduced the effects of nominal and real shocks affecting a macro-economy into his system through price expectations: if expectations are true, output in periodany tgiven period is at its natural level (that is, at its own trend). However, the well-known and widely accepted aggregate production function described by Sargent and Wallace (1975) also provides leeway for shocksthe (ε_t)white-noise shocks independent of price expectations–resulting in the accidental nature of equilibrium and in the inefficacy of countercyclical efforts of monetary policy.<ref>{{cite book |last=Galbács |first=Peter |title=The Theory of New Classical Macroeconomics. A Positive Critique |___location=Heidelberg/New York/Dordrecht/London |publisher=Springer |year=2015 |isbn= 978-3-319-17578-2 |doi=10.1007/978-3-319-17578-2 |url = http://link.springer.com/book/10.1007%2F978-3-319-17578-2}}</ref>

Lucas's model dominated new classical economic business cycle theory until 1982 when [[real business cycle theory]], starting with [[Finn E. Kydland]] and [[Edward C. Prescott]],<ref>{{Cite journal | last1 = Kydland | first1 = F. E. | last2 = Prescott | first2 = E. C. | title = Time to Build and Aggregate Fluctuations | journal = Econometrica | volume = 50 | issue = 6 | pages = 1345–1370 | doi = 10.2307/1913386 | year = 1982 | pmid = | pmc = }}</ref> replaced Lucas's theory of a money driven business cycle with a strictly supply based model that used technology and other real [[Shock (economics)|shocks]] to explain fluctuations in output.<ref>Snowdon and Vane (2005), 295.</ref>