Copyright © 2004 South-Western Mods 17-21, 30 Macro Analysis Part I

Copyright © 2004 South-Western

Mods Mods 17-21, 17-21,

3030Macro Analysis

Part I


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 is a period of declining real incomes, and rising unemployment

• Typically, economists term a downturn a recession if there are “2 quarters (1/2 year) of negative GDP growth”

• A depression is a severe recession.


THREE KEY FACTS ABOUT ECONOMIC FLUCTUATIONS

• Economic fluctuations are irregular and unpredictable.• Fluctuations are called “the business cycle”

• Most macroeconomic variables fluctuate together.

• As output falls, unemployment rises.

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



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



Percent ofLabor Force

(c) Unemployment Rate

0

2

4

6

8

10

12

1965 1970 1975 1980 1985 1990 1995 2000

Unemployment rate



The Basic Model of MacroeconomicShort-Run Economic Fluctuations

• Two variables are used to develop a model to analyze the macroeconomy and its short-run or real-time fluctuations.• GDP• Price level

• A graph is used to show the overall or AGGREGATE Demand for goods and the overall or AGGREGATE Supply of goods in the Economy as a whole

Aggregate Demand and Aggregate Supply

GDP=Quantity ofOutput

PriceLevel

0

Aggregatesupply

Aggregatedemand

Equilibriumoutput

Equilibriumprice level


AD

AS


The 2 Axes for our Macro

• We use GDP to measure the OVERALL demand for goods on the X axis.

• We use the Inflation Rate or GDP Deflator to measure the Price level on the Y axis

• But…because these are Macro models, we don’t usually use actual figures—we just use the concept of these measures to illustrate the scenarios.


The Basic Model of Economic Fluctuations

• The Basic Model of Aggregate Demand • 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-Demand Curve

GDP--Quantity ofOutput

PriceLevel

0

Aggregatedemand

P

Y Y2

P2

1. A decreasein the OVERALL Price level…

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



Why the Aggregate-Demand Curve Is Downward Sloping

• Remember:• The four components of GDP (Y) contribute to the

aggregate demand for goods and services.

Y = C + I + G + NX

• There are 3 ways that Price level then affects GDP growth/demand…



1.The Wealth Effect—affects the “C” demand• 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 Interest Rate Effect—affects the “I” demand

• A lower price level allows households to save money while reducing the interest rate for borrowers, thus allowing for more money for investment, and then greater spending by businesses on investment goods.

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



• The Net-Export Effect—affects the “NX” demand

• A lower U.S. price level means prices for goods produced in the U.S. are lower compared to the price of foreign goods. In other words, it makes U.S. goods a better deal for citizens and foreigners, increasing net exports.

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


Why the Aggregate-Demand CurveMight 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.


Shifts in the Aggregate Demand Curve

Quantity ofOutput

PriceLevel

0

Aggregatedemand, D1

P1

Y1

D2

Y2



• Shifts arising from • Consumption• Investment• Government Purchases• Net Exports


Shifts of the Aggregate Shifts of the Aggregate Demand CurveDemand Curve

• ∆C, ∆I, ∆G, ∆X - ∆M

•∆Expectations

•∆Wealth

•∆Existing Stock of Capital

•∆Fiscal Policy

•∆Monetary Policy



• Aggregate Demand Shifts worksheet

Documents

Copyright © 2004 South-Western Mods 17-21, 30 Macro Analysis Part I