Macroeconomics & The Global Economy Ace Institute of Management Chapter 9: Economic Fluctuation (Business Cycle Theory). Instructor Sandeep Basnyat [email protected] 9841 892281. Introduction. Continual ups and downs in the rate of growth of national income - PowerPoint PPT Presentation
IntroductionContinual ups and downs in the rate of growth of national incomeBusiness cycle is the alternating periods of expanding and contracting economic activity.
Growth rates of real GDP, consumptionPercent change from 4 quarters earlier
Growth rates of real GDP, consumption, investmentPercent change from 4 quarters earlier
UnemploymentPercent of labor force
Phases of Business CycleThere are four phases of business cycleProsperity or BoomRecessionDepression or SlumpRecovery or Revival ProsperityRecessionDepressionRevivalPeriodsOutput
Why does this happen? What are its implications to an economy?Different behavior of Price in short and long runDemand and supply shocks
Behaviour of PriceShort run Many prices are sticky at a predetermined level.Long run Prices are flexible, respond to changes in supply or demand.The economy behaves much differently when prices are sticky than flexible.
Aggregate demandThe aggregate demand curve shows the relationship between the price level and the quantity of output demanded. Also. from quantity equationM V = P Y If M and V are constant then, this equation implies an inverse relationship between P and Y causing downward sloping AD curve
The downward-sloping AD curve
Shifting the AD curveAn increase in the money supply shifts the AD curve to the right.
The short-run aggregate supply curveThe SRAS curve is horizontal:The price level is fixed at a predetermined level, and firms sell as much as buyers demand.
The long-run aggregate supply curve has enough time to respond to fixed K,L: does not depend on P, so LRAS is vertical. Increase in price is followed by increase in cost and suppliers do not have incentives to increase supply
The Aggregate Demand and supply curves
Y1an increase in aggregate demandFrom short run to Long run
A = initial equilibriumABCShort-run effects of an increase in M
Long-run effects of an increase in MP1
*CHAPTER 9 Introduction to Economic FluctuationsHow shocking!!!shocks: exogenous changes in agg. supply or demandShocks temporarily push the economy away from full employment.
*CHAPTER 9 Introduction to Economic FluctuationsThe effects of a negative demand shockAD shifts left, depressing output and employment in the short run.ABC
*CHAPTER 9 Introduction to Economic FluctuationsSupply shocksA supply shock alters production costs, affects the prices that firms charge. (also called price shocks)Examples of adverse supply shocks:Bad weather reduces crop yields, pushing up food prices. Workers unionize, negotiate wage increases. New environmental regulations require firms to reduce emissions. Firms charge higher prices to help cover the costs of compliance. Favorable supply shocks lower costs and prices.
*CHAPTER 9 Introduction to Economic FluctuationsCASE STUDY: The 1970s oil shocksEarly 1970s: OPEC coordinates a reduction in the supply of oil.Oil prices rose 11% in 1973 68% in 1974 16% in 1975Such sharp oil price increases are supply shocks because they significantly impact production costs and prices.
*CHAPTER 9 Introduction to Economic FluctuationsCASE STUDY: The 1970s oil shocksThe oil price shock shifts SRAS up, causing output and employment to fall. ABA
Notes for students:In the long run, supply has enough time to respond to fixed factors of production and becomes vertical.A 10% increase in P costs EVERYTHING 10% more- firm get 10% more revenue and also pays 10% more in wages, prices of intermediate goods, advertising, and so on. Thus, the firm has no incentive to increase output and supply curve becomes vertical.