Short-Run Economic Fluctuations ECON LOVES YOU-EMBRACE IT The
ballot is stronger than bullets. Joseph A. Schumpeter
Slide 2
The Skinny on Economic Terms Recession: Economy grows
significantly slower than normal trends Note that a Recession means
that GDP has been 2 quarters (6 months) Determined by the National
Bureau of Economic Research last 6-18 months and the unemployment
rate is 6-10%
Slide 3
Hit me Baby! * With More Terms* Expansion: this is when the
Economy is experiencing a even faster growth than normally
DEPRESSION!!!!! : A severe or protracted recession Note: The do not
have a numerical standard for unemployment, it is just higher than
a recession There is also a drastically low economic output THE
BUISNESS CYCLE LADIES AND GENTS
Slide 4
The Business Cycle The Boom Bust pattern found to the right and
the first slide is normal! After WWII recessions have been found to
be shorter! YAY! Expansions are longer!!! Some last as long as two
years!
Slide 5
Fluctuations in the Economys Aggregate Growth Unemployment:
During recessions, unemployment is high! *What is the percent
again?* Even when the expansion starts up, businesses are less
willing to hire workers Inflation: Changes with the business cycle
- When in a recession: rates -When in an expansion: rates The
decline in unemployment takes longer to get to a healthy 3-4%
Slide 6
GDPS Potential Output Potential Output: the quantity of goods
and services that an economy can produce using its resources
(capital and labor) at normal rates The Variable for this is Y*
Potential Output is where we would want to be producing wise in an
ideal Economy!
Slide 7
GDPS Output Gap Output Gap : the difference between the actual
output and the potential output The Variable for Actual Output;
Take a Gander: Output Gap= Y Y* ~Look at Figure 54 on page 93 por
favor~ Output potential output = resources not utilized ~
Unemployment rises when below potential output *( ~
Slide 8
Natural Rate of Unemployment Cyclical Unemployment: During
Recession *Not a part of the Natural Rate of Unemployment* *(
Structural and Frictional Unemployment: the level of unemployment
that would be present with actual output = potential output This
Natural Rate is subject to evolve with the Labor Market
Slide 9
Okuns Law Arthur Okun, one of Prez. Kennedys Economic advisors,
saw a correlation between the output gap and and the cyclical
unemployment level Cyclical E. THEN: Output Gap From 2 to 4% From 1
to 2% Every 1% Unemp. Differed from Natural Rate associated with 2%
deviation in output gap
Slide 10
Fluctuations in Output? Changes of in the rate of output=
changes in growth rate of potential output or actual output falls
above or below average Dependent upon: Growth rate of population,
rate of capital stock increasing, and technological advances! Ohh
Ahh *Mostly long term however* Short-Run fluctuation in output= the
widening of the gap between actual and potential output
Slide 11
How to Deal Prices would adjust to keep demand and supply equal
and thus utilize all resources actual and potential output will
stay closer in rate! YAY! Prices do not get modified, firms set
prices and sell as much or as little is demanded (Takes a while for
companies to take the hint) Firms adjust supply rather than prices,
when variations in demand occur, output is dependent upon the level
of aggregate demand Potential output! Note: This means that firms
see demand is down so they stop producing as much thus potential
output is not a priority any longer.
Slide 12
Aggregate Demand Aggregate Demand: the total desired spending
on final goods and services by all in an economy Ultimately, firms
will adjust prices to fix the market again towards normal
production Demand : raise prices= inflation rates rise Demand :
lower prices=inflation rates Price changes annihilate the
difference between actual and potential output! The Government
might need to step in to rid of the gap!
Slide 13
Lets Go Back for A Tic Consumption (C) spending by households
on a final goods and service Government Purchases (G) Spending by
all levels of government (not transfer payments) Investments (I)
Spending by firms on new capital goods and increases in inventories
(investment) Net Exports (NX) or (x- m) The Difference between
G&S produced in USA and sold elsewhere and value of G&S
made abroad and bought here (China basically)
Slide 14
John Maynard Keynes Created previous explanation of short-tem
fluctuations! Wrote this in the 1936 book The General Theory of
Employment, Interest, and Money The British economist wrote the
book to update microeconomic models that needed revisions due to
the Great Depression Developed the Keynesian Model
Slide 15
Keynesian Theory Causes of Short-Run Fluctuations = the
interaction between aggregate demand curve and the temporally
created aggregate supply curve *Figure 55 on page 97* *Pg. 99*
Keynesian model states that the Economys aggregate production and
price level are shown through the intersection of aggregate demand
and the short-run aggregate supply= the output gap is zero! Lets go
Back to the Future now but it will be the present slide once
thereTO SLIDE 23!
Slide 16
Aggregate Demand Curve Normal logic of prices = more demand
does not work in an aggregate economy - The decline in aggregate
prices means all prices of G&S will 3 reasons for the downward
(negative) relationship between aggregate demand and price
level
Slide 17
Reasons for the Relationship Foreign Exchange Effects ~ Prices
for Domestic goods= Foreign and Domestic consumers will purchase
goods rather than another countries Wealth Effects ~Aggregate price
= people gain more purchasing power with the same money they had
before ~Increases wealth and spending Interest Rate Effects ~
prices= access money go to less liquid entities to get put the
money to use ~ saving= interest rates do down and thus creating
more spending! Note: U.S. does not save at all! We need to borrow
from other countries!
Slide 18
Influence of AD curve Any effect on consumption decisions for
consumers or increasing investment by firms will make the aggregate
demand curve shift! Good effects (new technology for example that
benefits a market) makes a shift to the right Bad effects (an
external shock such as 9/11) makes the curve shift the left Shifts
can be created by the The Man spending the or taxing ~ spending=
all price levels up shift to right ~ spending= more cut backs -
shift to the left
Slide 19
Influence of AD Curve ~ taxes= higher household wealth MO
Money, MO Consumption (No problems here as long as there are no
shortages)
Slide 20
Aggregate Supply Curve *Figure 55 * The Aggregate Supply Curve
is drawn as an upward slope= quantity of G&S supplied with the
aggregate price levels Like Aggregate Demand, slopes upward for
different reason than we have learned thus far; it is sloped upward
to show the relationship between the price adjustments to come and
size of unpredicted sales Remember: Firms just fix prices to sell
as much or little as possible than in the long run adjust
prices
Slide 21
Oh Yea! More Aggregate Supply Curve Positioning dependent upon
the Economys long-run potential output and the assumption of the
aggregate price level~*Lets look to figure 55 on pg. 94* Two
Reasons for the Curve to Shift ~Change in the aggregate price level
- expected aggregate price level= aggregate supply shift upward
same type of reaction if Aggregate price level ~An Aggregate Supply
Shock! :0 (Good or Bad)
Slide 22
We Go back in time to the Time of Keynes and slide 16!!!
Slide 23
Welcome Back! Keynesian Models! Ahh Man: Negative Aggregative
demand shock ~Recession of 2001= investment spending = most firm
spending and brings higher interest rates! (9/11 and Fraud in Enron
helped make this worse) *Fig 56 on pg. 96* leftward shift ~Some
firms lower prices and aggregate price level Recovery through
adjustment ~Basically, firms are going to be producing much less
and it will take time for the AD and AS(short-run) to intersect
thus signaling output= potential Remember (Y*)
Slide 24
One More Keynesian Model *Figure 57 on pg 98* The shock of the
gas shortage caused a leftward shift of the aggregate short-run
supply and the aggregate price level is higher Firms see sales are
not good enough and finally cut prices and the aggregate supply
curve shifts to the right; All is good as prices will until price
level is back to normal Explanation of Recessions and Expansions=
unpredictable shocks to AD or AS strike Economy and cause
production to fall under potential (Short-run inflexibility of
prices cause the different phases)
Slide 25
Inflation and Keynes The models thus far did not factor in
inflation Quantity Equation: Long run aggregated price level if $
supply grows faster than potential output money supply= AD curve to
right but people expect prices to raise= AS(SR) shift upwards and
both AD and AS still intersect at potential *Fig. 58 pg 100 Shocks=
real inflation after moved from potential Example: Fund a military
build- up but borrow rather than tax ~ Government spending more
output but not expected and no order to keep it at this level,
different from potential output ~ in Aggregate Price =
Inflation!
Slide 26
Fiscal vs Monetary Policy Fiscal policy Increased government
spending to pick up the slack created by lack of consumers, firms,
and export flow of currency A tax cut + government spending =
consumers have more money to spend Economy ~AD shift to the right~
Monetary Policy
Slide 27
Why Do Either You Ask? Moving away from potential output costs
money and we want to make the most money we can possible!
Unemployment is bad for workers The economy loses the benefit of
resources that could have been produced but were not
Slide 28
Challenges to Enact Policies Hard to determine the Economy's
potential output= not sure what exactly needs to be done to fix it
Difficult to plan out the execution of the fiscal or monetary
policy
Slide 29
Even More Challenges! Collecting data on the aggregate economy
takes a long time! *Policies made with some key evidence but
nothing complete* Policies take time to actually make a difference
or even get passed the political circus ~Congress in known for
passing legislation for recessions that had already passed ~Most
times the Economy solves its idiosyncrasies and government enforced
policies might damage the progress
