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Short-Run Economic Fluctuations

Short-Run Economic Fluctuations . ECON LOVES YOU-EMBRACE IT “The ballot is stronger than bullets .” Joseph A. Schumpeter . The Skinny on Economic Terms. Recession : Economy grows significantly slower than normal trends Note that a Recession means that GDP has been .

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Short-Run Economic Fluctuations

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  1. Short-Run Economic Fluctuations

    ECON LOVES YOU-EMBRACE IT “The ballot is stronger than bullets.” Joseph A. Schumpeter
  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%
  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
  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!
  5. Fluctuations in the Economy’s 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%
  6. GDP’S 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!
  7. GDP’S 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 *( ~
  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
  9. Okun’s Law Arthur Okun, one of Prez. Kennedy’s 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
  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! OhhAhh *Mostly long term however* Short-Run fluctuation in output= the widening of the gap between actual and potential output
  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 demandPotential 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.
  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!
  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)
  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
  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 Economy’s 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 there…TO SLIDE 23!
  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
  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!
  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
  19. Influence of AD Curve ~ taxes= higher household wealth MO’ Money, MO’ Consumption (No problems here… as long as there are no shortages)
  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
  21. Oh Yea! More Aggregate Supply Curve Positioning dependent upon the Economy’s 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)
  22. We Go back in time to the “Time of Keynes” and slide 16!!!
  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*)
  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)
  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!
  26. Fiscal vs Monetary Policy Fiscal policy Monetary Policy Federal Reserve could control the cash flow in the economy and thus control interest rates! Above Potential output and inflation = Federal Reserve just limits money supply and drives interest rates , up, up and away! 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~
  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
  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
  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
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