C.9 The Short Run and the Long Run in Macroeconomics Flashcards
Potential GDP
The level of real GDP attained when firms are producing at capacity and labour is fully employed
Expansion
The period of a business cycle during which real GDP and employment are increasing
Keynesian economics
The perspective that business cycles represent disequilibrium, or non-market clearing behaviour
Classical economics
The perspective that business cycles can be explained using equilibrium analysis
Macroeconomic shock
An exogenous, positive or negative event that has a significant event on an important sector of the economy or on the economy as a whole
In the short run nominal prices and wages are _____ while in the long run are ______
sticky
flexible
What does it mean for a firm to compete in imperfectly competitive markets?
They have some control over prices
Reasons for price stickiness
- imperfectly competitive markets
- menu costs
- customers can get mad over increased costs
- information is costly
menu costs
costs in changing prices
how often to firms change prices
retailers just once or twice a year
Efficiency wages
Higher than equilibrium real wages to motivate employees to be more productive
The Great Moderation
The increased stability of real GDP after the early 1980s
Reasons for stabilized real GDP after 1950s
- The increasing importance of services and the declining importance of goods
- The establishment of E.I. and other gov’t transfers that provide funds to the unemployed
- Active fiscal and monetization policy
Real GDP eq’n
Y = Y^P + (Y-Y^P)
where,
Y^P = potential GDP
Y = real GDP
Output gap
The % deviation of real GDP from potential GDP
Output gap eq’n
Y~ = (Y-Y^P)/Y^P
What does the output gap measure
How fully the economy is employing its resources, such as labour, natural resources, and physical and human capital
When the output gap equals zero
The economy is producing at its long-run capacity and so its producing the max sustainable level of goods and services
When the output gap is greater than zer0
Economy is operating at a level greater than it can sustain in the long run
Cyclical unemployment rate
The difference between the unemployment rate and the natural unemployment rate
Okun’s Law
A statistical relationship between the cyclical unemployment rate and the output gap
Cyclical unemployment _____ during a recession
rises
Cyclical unemployment eq’n
u - u^N = -h*[(Y-Y^P)/Y^P] = -h*Y~ where, u = unemployment rate u^N = natural unemployment rate h = Okun's law coefficient
What does Okun’s law coefficient, h, represent
the effect a 1% drop in output on unemployment
Why is the Okun coefficient typically less than 1
labour hoarding: in recessions, firms do not reduce employment in line with the decline in output
Costs of the business cycle to workers
- Recessions do not necessarily have the same magnitude as expansions
- long periods of unemployment lead to lost skills
- lower income workers are hit harder
- negative effects of recessions on workers can last many years
A link between business cycles and growth
The uncertainty of business cycles can reduce investment spending
Procyclical variable
An economic variable that moves in the same direction as real GDP - increasing during expansions and decreasing during recessions
Examples of procyclical variables
- employment
- investment spending
- spending on durable goods
Examples of countercyclical variables
- unemployment rate
Hysteresis
Even when output returns to potential, employment does not
Leading indicators
Variables that reliably indicate a future recession or expansion
Examples of leading indicators
- avg work week hours, manufacturing
- housing index
- US leading index
- money supply
- new orders, durable goods
- stock price index
- retail trade, furniture and appliances
- business and personal services employment
Multiplier effect
A series of induced increases (or decreases) in consumption spending that results from an initial increase (or decrease) in autonomous expenditure; this effect amplifies the effect of economic shocks on real GDP
Autonomous expenditure
Spending that is independent of income
Multiplier
The change in equilibrium GDP divided by the change in autonomous expenditure
Autonomous expenditure multiplier eq’n
(Change in GDP/Change in autonomous expenditure) = 1/(1-m)
where,
m = the proportion of an increase in income that is spent on domestic goods and services
