12 SHORT-RUN ECONOMIC FLUCTUATIONS Chapter 33 Aggregate Demand and Aggregate Supply

12 SHORT-RUN ECONOMIC

FLUCTUATIONS

Chapter 33Aggregate Demand

and Aggregate Supply

Short-Run Economic Fluctuations

• Economic activity fluctuates from year to year.– In most years production of goods and services

rises.– On average over the past 50 years, production

in the U.S. economy has grown by about 3 percent per year.

– In some years normal growth does not occur, causing a recession.

Short-Run Economic Fluctuations

• A recession 衰退 is a period of declining real incomes, and rising unemployment.

• A depression 萧条 is a severe recession.

33.1 THREE KEY FACTS ABOUT ECONOMIC

FLUCTUATIONS

33.1.1. Fact 1: Economic fluctuations are irregular and unpredictable

• Fluctuations in the economy are often called the business cycle. Economic fluctuations correspond to changes in business conditions.

• When real GDP grow rapidly, business is good. During such periods of economic expansion, firms find that customers are plentiful and that profits are growing.

• On the other hand, when real GDP falls during recessions, businesses have trouble. During such periods of economic contraction, most firms experience declining sales and dwindling profits.

Figure 1 A Look At Short-Run Economic Fluctuations

Billions of1996 Dollars

Real GDP

(a) Real GDP

$10,000

9,000

8,000

7,000

6,000

5,000

4,000

3,000

2,0001965 1970 1975 1980 1985 1990 1995 2000

Figure 1a. A Look At Short-Run Economic Fluctuations of China

Fi gure. 1952- 2005 real GDP i n Chi na

0

5E+11

1E+12

2E+12

2E+12

3E+12

3E+12

1952

1955

1958

1961

1964

1967

1970

1973

1976

1979

1982

1985

1988

1991

1994

1997

2000

2003

33.1.2 Fact 2: Most macroeconomic variables fluctuate together

• Most macroeconomic variables that measure some type of income, spending, or production fluctuate closely together. When real GDP falls in a recession, so do personal income, corporate profits, consumer spending, investment spending, industrial production, retail sales, home sales, auto sales, and so on. Because recessions are economy-wide phenomena, they show up in many sources of macroeconomic data.

• Although many macroeconomic variables fluctuate together, they fluctuate by different amounts.


Billions of1996 Dollars

(b) Investment Spending

$1,800

1,600

1,400

1,200

1,000

800

600

400

2001965 1970 1975 1980 1985 1990 1995 2000

Investment spending

33.1.3 Fact 3: As output falls, unemployment rises

• Change in the economy’s output of goods and services are strongly correlated with changes in the economy’s utilization of its labor force. In other words, when real GDP declines, the rate of unemployment rises.

• Changes in real GDP are inversely related to changes in the unemployment rate.

• During times of recession, unemployment rises substantially.


Percent ofLabor Force

(c) Unemployment Rate

0

2

4

6

8

10

12

1965 1970 1975 1980 1985 1990 1995 2000

Unemployment rate

33.2 EXPLAINING SHORT-RUN

ECONOMIC FLUCTUATIONS

33.2.1 How the Short Run Differs from the Long Run

• All of this previous analysis was based on two related ideas—the classical dichotomy and monetary neutrality.

• Most economists believe that classical theory describes the world in the long run but not in the short run.

• According to classical macroeconomic theory, Changes in the money supply affect nominal variables but not real variables in the long run.

• The assumption of monetary neutrality is not appropriate when studying year-to-year changes in the economy.

33.2.2 The Basic Model of Economic Fluctuations

• Two variables are used to develop a model to analyze the short-run fluctuations.

– The first variable is the economy’s output of goods and services measured by real GDP.

– The second variable is the overall price level measured by the CPI or the GDP deflator.


• The Basic Model of Aggregate Demand and Aggregate Supply

– Economist use the model of aggregate demand and aggregate supply to explain short-run fluctuations in economic activity around its long-run trend.


• The Basic Model of Aggregate Demand and Aggregate Supply

– The aggregate-demand curve shows the quantity of goods and services that households, firms, and the government want to buy at each price level.

– The aggregate-supply curve shows the quantity of goods and services that firms choose to produce and sell at each price level.

Figure 2 Aggregate Demand and Aggregate Supply...

Quantity ofOutput

PriceLevel

0

Aggregatesupply

Aggregatedemand

Equilibriumoutput

Equilibriumprice level

33.3 THE AGGREGATE-DEMAND CURVE

33.3 THE AGGREGATE-DEMAND CURVE

• The four components of GDP (Y) contribute to the aggregate demand for goods and services.

Y = C + I + G + NX

Figure 3 The Aggregate-Demand Curve...

Quantity ofOutput

PriceLevel

0

Aggregatedemand

P

Y Y2

P2

1. A decreasein the pricelevel . . .

2. . . . increases the quantity ofgoods and services demanded.

33.3.1 Why the Aggregate-Demand Curve Is Downward Sloping

1. The Price Level and Consumption: The Wealth Effect

2. The Price Level and Investment: The Interest Rate Effect

3. The Price Level and Net Exports: The Exchange-Rate Effect


1. The Price Level and Consumption: The Wealth Effect 财富效应 (Arthur Pigou, 1877-1959)

– A decrease in the price level makes consumers feel more wealthy, which in turn encourages them to spend more.

– This increase in consumer spending means larger quantities of goods and services demanded.


2. The Price Level and Investment: The Interest Rate Effect (John Maynard Keynes, 1883-1946)

– A lower price level reduces the interest rate, which encourages greater spending on investment goods.

– This increase in investment spending means a larger quantity of goods and services demanded.


3. The Price Level and Net Exports: The Exchange-Rate Effect 汇率效应 (Robert Mundell and Marcus Fleming)

– When a fall in the U.S. price level causes U.S. interest rates to fall, the real exchange rate depreciates, which stimulates U.S. net exports.

– The increase in net export spending means a larger quantity of goods and services demanded.

33.3.2 Why the Aggregate-Demand Curve Might Shift

• The downward slope of the aggregate demand curve shows that a fall in the price level raises the overall quantity of goods and services demanded.

• Many other factors, however, affect the quantity of goods and services demanded at any given price level.

• When one of these other factors changes, the aggregate demand curve shifts.


1) Shifts arising from Consumption: any event that changes how much people want to consume at a given price level shifts the aggregate-demand curve. (a tax cut,a stock market boom; a tax hike, a stock market decline.)


2) Shifts arising from Investment: any event that changes how much firms want to invest at a given price level also shifts the aggregate-demand curve. (optimism about the future; a fall in interest rates due to an increase in the money supply; pessimism about the future, a rise in interest rates due to an decrease in the money supply.)


3) Shifts arising from Government Purchases: The most direct way that policymakers shift the aggregate-demand curve is through government purchases. (greater spending on defense or highway construction; a cutback in defense or highway spending.)


4) Shifts arising from Net Exports: any event that changes net exports for a given price level also shifts aggregate demand. (a boom overseas, an exchange-rate depreciation; a recession overseas, an exchange-rate appreciation)

Shifts in the Aggregate Demand Curve

Quantity of Output

PriceLevel

0

Aggregate demand, D1

P1

Y1

D2

Y2

33.4 THE AGGREGATE-SUPPLY

CURVE

33.4 THE AGGREGATE-SUPPLY CURVE

• In the long run, the aggregate-supply curve is vertical.

• In the short run, the aggregate-supply curve is upward sloping.

33.4.1 Why the Aggregate-Supply Curve is Vertical in the Long-Run• The Long-Run Aggregate-Supply Curve

– In the long run, an economy’s production of goods and services depends on its supplies of labor, capital, and natural resources and on the available technology used to turn these factors of production into goods and services.

– Because the price level does not affect these long-run determinants of real GDP, the long-run aggregate-supply is vertical.

Figure 4 The Long-Run Aggregate-Supply Curve

Quantity ofOutput

Natural rateof output

PriceLevel

0

Long-runaggregate

supply

P2

1. A changein the pricelevel . . .

2. . . . does not affect the quantity of goods and services supplied in the long run.

P

33.4.1 Why the Aggregate-Supply Curve is Vertical in the Long-Run

• The Long-Run Aggregate-Supply Curve

– The long-run aggregate-supply curve is vertical at the natural rate of output.

– This level of production is also referred to as potential output or full-employment output.

33.4.2 Why the Long-Run Aggregate-Supply Curve Might Shift

• Any change in the economy that alters the natural rate of output shifts the long-run aggregate-supply curve.

• The shifts may be categorized according to the various factors in the classical model that affect output.


• Shifts arising

– Labor

– Capital

– Natural Resources

– Technological Knowledge


• Shifts arising from labor: An increase in the quantity of labor available (perhaps due to a fall in the natural rate of unemployment, an increase in immigration from abroad.) shift the aggregate-supply curve to the right.

• A decrease in the quantity of labor available (perhaps due to a rise in the natural rate of unemployment, many workers left the economy to go abroad.) shift the aggregate-supply curve to the left.


• Shifts arising from capital: An increase in the economy’s capital stock (physical or human capital) increases productivity and, thereby, the quantity of goods and services supplied. As a result, the aggregate-supply curve shifts to the right.

• A decrease in the economy’s capital stock (physical or human capital) decreases productivity and the quantity of goods and services supplied. shifting the aggregate-supply curve to the left.


• Shifts arising from Natural Resources: An increase in the availability of natural resources (land, minerals, and weather) shifts the aggregate-supply curve to the right.

• A decrease in the availability of natural resources shifts the aggregate-supply curve to the left.


• Shifts arising from Technology: An advance in technological knowledge shifts the aggregate-supply curve to the right.

• A decrease in technological knowledge shifts the aggregate-supply curve to the left.

Figure 5 Long-Run Growth and Inflation

Quantity ofOutput

Y1980

AD1980

AD1990

Aggregate Demand, AD2000

PriceLevel

0

Long-runaggregate

supply,LRAS1980

Y1990

LRAS1990

Y2000

LRAS2000

P1980

1. In the long run,technological progress shifts long-run aggregate supply . . .

4. . . . andongoing inflation.

3. . . . leading to growthin output . . .

P1990

P2000

2. . . . and growth in the money supply shifts aggregate demand . . .

33.4.3 A New Way to Depict Long-Run Growth and Inflation

• Although there are many forces that govern the economy in the long-run and can in principle cause such shifts, the two most important in practice are technology and monetary policy.

• Technological progress enhances the economy’s ability to produce goods and services, and this continually shifts the long-run aggregate-supply curve to the right.

• At the same time, because the Fed increases the money supply over time, the aggregate-demand curve also shifts to the right. The result is trend growth in output and continuing inflation.

33.4.3 A New Way to Depict Long-Run Growth and Inflation

• Short-run fluctuations in output and price level should be viewed as deviations from the continuing long-run trends.

33.4.4 Why the Aggregate-Supply Curve Slopes Upward in the Short Run

• In the short run, an increase in the overall level of prices in the economy tends to raise the quantity of goods and services supplied.

• A decrease in the level of prices tends to reduce the quantity of goods and services supplied.

Figure 6 The Short-Run Aggregate-Supply Curve

Quantity ofOutput

PriceLevel

0

Short-runaggregate

supply

1. A decreasein the pricelevel . . .

2. . . . reduces the quantityof goods and servicessupplied in the short run.

Y

P

Y2

P2


• The Sticky-Wage Theory 粘性工资理论

• The Sticky-Price Theory 　粘性价格理论

• The Misperceptions Theory 错觉理论


• 33.4.4.1. The Sticky-Wage Theory• According to the sticky-wage theory, the short-run

aggregate-supply curve slopes upward because nominal wages are slow to adjust, or are “sticky” in the short run.

• Because wages do not adjust immediately to a fall in the price level. A lower price level makes employment and production less profitable. So firms reduce the quantity of goods and services they supply.


• 33.4.4.2. The Sticky-Price Theory• The sticky-wage theory emphasizes that nominal

wages adjust slowly over time. The sticky-price theory emphasizes that the prices of some goods and services adjust sluggishly in response to changing economic conditions.

• Because not all prices adjust instantly to changing conditions, an unexpected fall in the price level leaves some firms with higher-than-desired prices, and these higher-than-desired prices depresses sales and induces firms to reduce the quantity of goods and services they produce.


• 33.4.4.3. The Misperceptions Theory• Changes in the overall price level temporarily

mislead suppliers about what is happening in the individual markets in which they sell their output. As a result of these short-run misperceptions, suppliers respond to changes in the level of prices, and this response leads to an upward-sloping aggregate-supply curve.

• A lower price level causes misperceptions about relative prices. And these misperceptions induce suppliers to decrease the quantity of goods and services supplied.


• All three theories suggest that output deviates from its natural rate when the price level deviates from the price level that people expected. We can express this mathematically as follows:

Quantityof outputsupplied

Naturalrate ofoutput

ActualPricelevel

Expectedpricelevel

－+=

Where is a number that determines how much output responds to unexpected changes in the price level.

33.4.5 Why the Short-Run Aggregate-Supply Curve Might Shift

• Shifts arising

– Labor

– Capital

– Natural Resources.

– Technology.

– Expected Price Level.


• When thinking about what shifts the short-run aggregate-supply curve, we have to consider all those variables that shift the long-run aggregate-supply curve plus a new variable----the expected price level—that influences sticky wages, sticky prices, and misperceptions.


• An increase in the expected price level reduces the quantity of goods and services supplied and shifts the short-run aggregate supply curve to the left.

• A decrease in the expected price level raises the quantity of goods and services supplied and shifts the short-run aggregate supply curve to the right.

Variable Impact on aggregate supplyPotential output

Inputs

Supplies of capital, labor, and land are the important inputs. Potential outputcomes when unemployment of labor and other resources is at non-inflationary levels. Growth of inputs increases potential output andaggregate supply.

Technologyandefficiency

Innovation, technological improvement, and increased efficiency increasethe level of potential output and rise aggregate supply.

Production costs

WagesLower wages lead to lower production costs; lower costs mean that quantitysupplied will be higher at every price level for a given potential output.

Imports pricesA decline in foreign prices or an appreciation in the exchange rate reducesimport prices. This lead to lower production costs and raises aggregatesupply.

Other input costsLower oil prices or less burdensome environmental regulation lowersproduction costs and thereby raises aggregate supply.

TABLE 31-1 Aggregate Supply Depends upon Potential Output and Production CostsAggregate supply relates total outputs supplied to the price level. Behind the AS curve liefundamental factors of productivity as represented by potential outpu

Appendix 33. Potential output is not maximum output

1) We must emphasize a subtle point about potential output: Potential output is the maximum sustainable output but not the absolute maximum output that an economy can produce. The economy can operate with output levels above potential output for a short time, and indeed this was the situation during the long economic expansion of the late 1990s.

2) A useful analogy is someone running a marathon. Think of potential output as the maximum speed that a marathoner can run without becoming “overheated” and dropping out from exhaustion. Clearly, the runner can run faster than the sustainable pace for a while, just as the U.S. economy grew faster than its potential growth rate during the 1990s. But over the entire course, the economy, like the marathoner, can produce only at a maximum sustainable “speed”, and this sustainable output speed is what we call potential output. (Samuelson, Economics, 17th edition, p663.)

A.1.2. Input Costs

1) The most important cost is labor earnings, which constitute about three-quarters of the overall cost of production for a country like the United States.

2) For the small open economies like the Netherlands or Hong Kong, import costs play an even greater role than wages in determining aggregate supply.

Pri

ce le

vel

Real output

AS

(a) Increase in Potential OutputPotential output

AS'

Q

P

Figure 31-1. How Do Growth in Potential Output and Cost Increases Affect Aggregate Supply?

QP QP'

Pri

ce le

vel

Real output

AS

(b) Increase in Costs

Potential output

AS"

Q

P

Figure 31-1. How Do Growth in Potential Output and Cost Increases Affect Aggregate Supply?

QP

33.5 TWO CAUSES OF ECONOMIC

FLUCTUATIONS

Figure 7 The Long-Run Equilibrium


Quantity ofOutput

PriceLevel

0

Short-runaggregate

supply

Long-runaggregate

supply

Aggregatedemand

AEquilibriumprice

Figure 8 A Contraction in Aggregate Demand

Quantity ofOutput

PriceLevel

0

Short-run aggregatesupply, AS

Long-runaggregate

supply

Aggregatedemand, AD

AP

Y

AD2

AS2

1. A decrease inaggregate demand . . .

2. . . . causes output to fall in the short run . . .

3. . . . but over time, the short-runaggregate-supplycurve shifts . . .

4. . . . and output returnsto its natural rate.

CP3

BP2

Y2

33.5 TWO CAUSES OF ECONOMIC FLUCTUATIONS

• Shifts in Aggregate Demand

– In the short run, shifts in aggregate demand cause fluctuations in the economy’s output of goods and services.

– In the long run, shifts in aggregate demand affect the overall price level but do not affect output.

33.5 TWO CAUSES OF ECONOMIC FLUCTUATIONS

• An Adverse Shift in Aggregate Supply

– A decrease in one of the determinants of aggregate supply shifts the curve to the left:

• Output falls below the natural rate of employment.

• Unemployment rises.

• The price level rises.

33.5.1 The Effects of a Shift in Aggregate Supply

• Now suppose that suddenly some firms experience an increase in their costs of production. For example, bad weather in farm states might destroy some crops, driving up the cost of producing food products. Or a war in the Middle East might interrupt the shipping of crude oil, driving up the cost of producing oil products.

• What is the macroeconomic impact of such an increase in production costs? For any given price level, firms now want to supply a smaller quantity of goods and services.

Figure 10 An Adverse Shift in Aggregate Supply

Quantity ofOutput

PriceLevel

0

Aggregate demand

3. . . . and the price level to rise.

2. . . . causes output to fall . . .

1. An adverse shift in the short-run aggregate-supply curve . . .

Short-runaggregate

supply, AS

Long-runaggregate

supply

Y

AP

AS2

B

Y2

P2


• Policy Responses to Recession

– Policymakers may respond to a recession in one of the following ways:

• Do nothing and wait for prices and wages to adjust.

• Take action to increase aggregate demand by using monetary and fiscal policy.

Figure 11 Accommodating an Adverse Shift in Aggregate Supply

Quantity ofOutput


PriceLevel

0

Short-runaggregate

supply, AS

Long-runaggregate

supply

Aggregate demand, AD

P2

AP

AS2

3. . . . whichcauses theprice level to rise further . . .

4. . . . but keeps outputat its natural rate.

2. . . . policymakers canaccommodate the shiftby expanding aggregatedemand . . .

1. When short-run aggregatesupply falls . . .

AD2

CP3


• Stagflation

– Adverse shifts in aggregate supply cause stagflation—a period of recession and inflation.

• Output falls and prices rise.

• Policymakers who can influence aggregate demand cannot offset both of these adverse effects simultaneously.

Summary

• All societies experience short-run economic fluctuations around long-run trends.

• These fluctuations are irregular and largely unpredictable.

• When recessions occur, real GDP and other measures of income, spending, and production fall, and unemployment rises.

Summary

• Economists analyze short-run economic fluctuations using the aggregate demand and aggregate supply model.

• According to the model of aggregate demand and aggregate supply, the output of goods and services and the overall level of prices adjust to balance aggregate demand and aggregate supply.

Summary

• The aggregate-demand curve slopes downward for three reasons: a wealth effect, an interest rate effect, and an exchange rate effect.

• Any event or policy that changes consumption, investment, government purchases, or net exports at a given price level will shift the aggregate-demand curve.

Summary

• In the long run, the aggregate supply curve is vertical.

• The short-run, the aggregate supply curve is upward sloping.

• The are three theories explaining the upward slope of short-run aggregate supply: the misperceptions theory, the sticky-wage theory, and the sticky-price theory.

Summary

• Events that alter the economy’s ability to produce output will shift the short-run aggregate-supply curve.

• Also, the position of the short-run aggregate-supply curve depends on the expected price level.

• One possible cause of economic fluctuations is a shift in aggregate demand.

Summary

• A second possible cause of economic fluctuations is a shift in aggregate supply.

• Stagflation is a period of falling output and rising prices.

Mankiw33. Questions for Review1. List and explain the three reasons why the aggregate-

demand curve is downward sloping?(Mankiw,ch33-pp729-731.)

2. Explain why the long-run aggregate-supply curve is vertical? (Mankiw,ch33-p734.)

3. List and explain the three theories why the short-run aggregate-supply curve is up sloping?(Mankiw,ch33-p738-740.)

4. What might shift the aggregate-demand to the left? Use the model of aggregate demand and aggregate supply to trace through the effects of such a shift.(Mankiw,ch33,p731-733.)

5. What might shift the aggregate-supply to the left? Use the model of aggregate demand and aggregate supply to trace through the effects of such a shift. (Mankiw,ch33-pp735-736. & p742-table2.)

复习题1.写出当经济进入衰退时下降的两个宏观经济变量。写出当经济进入衰退时上升的一个宏观经济变量。

2. 画出一个有总需求、短期总供给和长期总供给的图。仔细地标出正确的轴。

3. 列出并解释总需求曲线向右下方倾斜的三个原因。4. 解释为什么长期总供给曲线是垂线。5. 列出并解释为什么短期总供给曲线向右上方倾斜的三种理论。

6. 什么因素引起总需求曲线向左移动？用总需求和总供给模型来探讨这种移动的影响。

7. 什么因素引起总供给曲线向左移动？用总需求和总供给模型来探讨这种移动的影响。

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12 SHORT-RUN ECONOMIC FLUCTUATIONS Chapter 33 Aggregate Demand and Aggregate Supply