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Mods Mods 17-21, 17-21,
3030Macro Analysis
Part I
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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.
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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.
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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
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A Look At Short-Run Economic Fluctuations
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
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A Look At Short-Run Economic Fluctuations
Percent ofLabor Force
(c) Unemployment Rate
0
2
4
6
8
10
12
1965 1970 1975 1980 1985 1990 1995 2000
Unemployment rate
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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
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AD
AS
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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.
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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.
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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…
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Why the Aggregate-Demand Curve Is Downward Sloping
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.
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Why the Aggregate-Demand Curve Is Downward Sloping
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.
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Why the Aggregate-Demand Curve Is Downward Sloping
• 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.
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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.
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Shifts in the Aggregate Demand Curve
Quantity ofOutput
PriceLevel
0
Aggregatedemand, D1
P1
Y1
D2
Y2
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Why the Aggregate-Demand CurveMight Shift
• Shifts arising from • Consumption• Investment• Government Purchases• Net Exports
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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
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Why the Aggregate-Demand CurveMight Shift
• Aggregate Demand Shifts worksheet