Chapter 10 - Introduction to Economic Fluctuations Flashcards
define business cycle
what are 3 characteristics
fluctuations of aggregate economic activity (expansion, contraction)
characteristics:
1. complete cycle: one extreme point to the next
2. not periodic: no predicted intervals
3. peaks and troughs are turning points
How is aggregate economic activity measured?
GDP tracking
On the normal growth path, what happens to GDP in the LR and SR
increases in LR, fluctuates in SR
What is the avereage % increase in CAD GDP growth
2.8% per year
is consumption or investment more volatile to changes in GDP?
What is order of volatility
investment is more volatile
Consumption less volatile: because people use savings to maintain basic standard of living
order of volatility:
investment > GDP > Consumption
Define Okun’s law and the ratio
negative relationship b/w GDP and unemployment
With every 1% change in GDP, unemployment changes (negatively) by 0.5% (half)
what is the REAL and ASSUMED equation for change in U rate? What do values represent
change(U/L) = -0.33 * %change in Real GDP - 2.88)
- 2.88 average LR growth GDP
change(U?L) = -0.5 * %change real GDP - 2.88
what is the goal of the index of leading economic indicators? What is it used for?
goal to forecast changes in economic activity 6-9 months into future (6-9mo)
Used by business/gov to plan/predict recessions, prevent severity
What is similar to all components of LEI index? list some components (10 total)
all data is readily available for all to use
Components:
- average workweek manufacturing
- claims received for EI
- new orders for durable goods
- conference board of index of consumer confidence
- index of stock prices
- US leading indicator
- housing index
- money supply
- yield spread (3m t-bill - 3m prime rate)
- index of commodity prices
what is the non-classical model?
model in SR, when prices are sticky the market behaves much differently than classical model (LR)
in the non-classical model, what affects demand and what does demand impact
demand impacts: output and employment
impacts demand: fiscal policy (G and T), monetary policy (M), other factors (exogenous changes in C or I)
In the very short run (non-classical model)
what is fixed?
What graphically look like?
What does AD determine?
fixed: prices inputs&outputs (since already set)
graph:
- SRAS horizontal (since p fixed)
- AD (-slope) determines EQM
Result: AD determines Y (not P, fixed)
the short run (non classical model)
What is fixed?
What graphically look like?
What does AD determine
fixed: price of inputs (not output, can react to demand and change SP)
Graphically:
- SRAS positively sloped (P rise, AS rise)
- AD: determines EQM Y and P
the long run (non classical model)
What is fixed?
What graphically look like?
What does AD determine
fixed: nothing (flexible and change proportionally)
graphical implication:
LRAS perfectly inelastic (vertical)
AD: determines price level (not Y)
what is the paradigm most mainstream economists and policymakers use to think about economic fluctuations and policies to stabilize the economy?
model of AD-AS (non classical)
what does the non classical model show
hoe economy behaves in SR and LR, how determine P and Y in SR/LR
Define AD curve (nonclassical)
Explain slope
What shifts the AD curve?
AD: relationship b/w P and QD output
slope: MV=PY (M,V constant)
tf: P and Y negative relationship (axis)
shifts: money supply determines dollar value (MV=PY) of all transactions since V fixed
- Ms rise –> AD shift right (high Y for each P)
- Ms fall -> AD shift left (low Y for each P)
Define LRAS curve (nonclassical)
Explain slope?
What shifts the LRAS curve?
Impact of Ms change (AD)
vertical, no relationship b/w Y and P
LR prices increase proportionally (no incentive to increase Y)
slope = infinity
Why? in LR, AS determined by factors (fixed in LR)
shifts LRAS:
- natural disasters -> decrease K,L -> LRAS left
If Ms change -> AD change -> price change & Y unchanged (since LRAS fixed)`
Define SRAS curve (nonclassical)
Explain slope?
What shifts the SRAS curve?
Impact of Ms change (AD)
SRAS: prices sticky in SR, firms sell as much as possible
slope: SRAS horizontal (slope=0)
- SR: no inflation, P unchanged (Y changes only)
Shifts: if P level changes in SR
Changes in Ms -> change AD -> changes Y (not P since SRAS fixed)
How do move from SR to LR?
prices become unstuck (can either fall or rise) and adjust to the LR EQM
When do prices rise/fall/remain constant when moving from SR to LR?
Prices rise: SR EQM Y > Ybar (inflationary gap)
Prices fall: SR EQM Y < Ybar (recessionary gap)
Price constant: SR EQM = Ybar
When does LR EQM happen? How does this happen
SRAS = LRAS = AD
after SR EQM, economy will adjust back to being equal in LR due to price adjustments
what is a shock?
an exogenous change in AS or AD that temporarily push economy away from EQM
What shocks (shifts) AD curve?
M and V changes
What happens in a Negative Demand shock?
(examples of shocks, move from SR EQM to LR EQM)
Examples of shocks:
- V falls –> AD left
- M rise –> AD left
SR EQM: (after AD shift left)
- AD moves to SRAS (Y1 < Ybar)
- Result: P constant, Y falls (unemployment)
LR EQM: (after Y falls)
- Y1 < Ybar (recessionary gap)
- over time, P falls (and SRAS) to EQM in LR
- LR EQM: where SRAS1 = AD1 = LRAS
- Result: P fall, Y constant
What happens in a positive demand shock:
(examples of shocks, move from SR EQM to LR EQM)
Examples of shocks:
- V rise –> AD right
- M falls –> AD right
SR EQM: (after AD shift right to R1)
- AD moves to SRAS (Y1 > Ybar)
- Result: P constant, Y rises (employment)
LR EQM: (after Y rises)
- Y1 > Ybar (inflationary gap)
- over time, P rises (and SRAS) to EQM in LR
- LR EQM: where SRAS1 = AD1 = LRAS
- Result: P rises and Y constant
What happens in a negative supply shock:
(examples of shocks (4), move from SR EQM to LR EQM)
Examples of shocks:
- natural disasters –> SRAS aka P rise
- workers unionize –> SRAS aka P rise
- environmental regulations –> SRAS aka P rise
- price shocks (oil) –> SRAS aka P rise
SR EQM: (after SRAS = P rises to SRAS1)
- SR EQM: where SRAS1 = AD
- Result: P rise (inflation), Y falls (unemployment)
LR EQM: (after Y falls)
- Y1 < Ybar (recessionary gap)
- over time, P falls (and SRAS) to EQM in LR
- LR EQM: where SRAS1 = SRAS = AD = LRAS
- result: P unchanged, Y unchanged
4 Examples of negative supply shocks aka price shocks
- natural disasters –> SRAS aka P rise
- workers unionize –> SRAS aka P rise
- environmental regulations –> SRAS aka P rise
- price shocks (oil) –> SRAS aka P rise
What happens in a positive supply shock:
(examples of shocks , move from SR EQM to LR EQM)
Examples of shocks:
- lower costs and prices –> SRAS aka P fall
SR EQM: (after SRAS falls to SRAS1)
- SR EQM where SRAS1 = AD
- Result: P falls (deflation), Y rises (employment)
LR EQM: (after Y rise, P falls)
- Y1 > Ybar: inflationary gap
- over time, P falls (and SRAS) to EQM in LR
- LR EQM: where SRAS1 = SRAS = AD = LRAS
- Result: P unchanged, Y unchanged
How does the government intervene? Why? What policy is used?
government intervention uses Monetary policy to return to EQM faster than waiting for markets to correct themselves, by influencing demand to meet at LRAS
What is stabilization policy
policy actions aimed at reducing the severity of SR economic fluctuations
use of macro policies to attempt to keep output as close to the natural level as possible
how does stabilization policy accomodate?
as soon as shock occurs, central bank will inflict policy (depends on speed)
What impact does government intervention on adverse supply shocks?
How do they influence demand to meet at LRAS
Without gov intervention:
- From: A -> B -> A (no P or Y change LR)
With gov intervention:
- From: A -> B -> C (P rise, Y same in LR)
TF: gov intervention with monetary policy to change demand and influence demand to meet at the LRAS
- Result: permanent inflation
What is the most favorable shock
positive supply shock
- increases production and employment, decreases price
What is the lease favorable shock? What is this effect called?
adverse supply shock:
- decreases production and employment, increase price
Stagflation: when the economy experiences inflation and unemployment (after adverse supply shock)
