Chapter 26 Flashcards
economic fluctuations/ business cycles
short-run changes in the growth of GDP
Can government policies avoid fluctuations?
No, government policies can only reduce the severity of fluctuations.
What is a trend line?
A trend line is a line drawn over pivot highs or under pivot lows to show the prevailing direction of price. Trend lines are a visual representation of support and resistance in any time frame. They show direction and speed of price, and also describe patterns during periods of price contraction.
How do we calculate the percentage deviation?
100 * (real GDP-Trend)/trend
economic expansion (booms)
Periods between recessions. Accordingly, an economic expansion begins at the end of one recession and continues until the start of the next recession.
What are recessions? (contractions, downturns)
Periods in which real GDP falls.
peak point
high point of real GDP, before recession begins
trough
low point of real GDP during the recession (corresponds to the end of recession)
What are the 3 key properties of economic fluctuations?
1) co-movement of many aggregate macroeconomic variables
- many economic variables grow and contract together
- ex: consumption and investment co-move, employment and GDP co-move, unemployment moves negatively with GDP
2) Limited predictability of turning points
- recessions do not follow a repetitive, easily predictable cycle
3) Persistence in the rate of economic growth
- economic growth is not random
- recession this quarter, probably still recession the next quarter
The great depression
Refers to the severe contraction that started in 1929, reaching a low point for real GDP in 1933. The period or below-trend real GDP did not end until the buildup to WW2 in the late 30’s.
- the crisis deepened as stock markets around the world continued to fall. At its bottom in 1933. stock market was about 80% below its peak 4 years earlier.
- millions of US farmers and homeowners went bankrupt.
- thousands of failing banks
What is depression?
the term is typically used to describe a prolonged recession with an unemployment rate of 20% or more.
labor market eqm
intersection of LS curve and LD curve
downward wage rigidity
- with downward wage rigidity, firms are unable or unwilling to cut nominal wages because of contractual restrictions or because they are concerned that wage cuts would reduce worker morale and adversely affect productivity
- produce unemployment
capacity utilisation
-rate of utilisation of physical K (recession+reduction of capital utilisation)
What are the most important sources of recession?
-shift in the labour demand curve
Sources of fluctuations
1) Real business cycle theory (emphasises changing productivity and technology)
2) Keynesian theory (emphasises changing expectations about the future)
3) Financial and monetary theories (emphasise change in prices and r)
Real business cycle theory
-a school of thought that emphasises the role of changes in the technology in causing economic fluctuations
- technology differences across firms and workers in different countries help explain differences in cross-country income and growth
- research and development leads firms to invest more valuable products. This will increase the value of marginal product of labour => firms expand their operations => increase their labour demand
- firms are also likely to increase their productivity capacity, raising the level of investment in the economy => higher household income (employment increase, wages rise, rising corporate incomes) => households will raise their consumption
-emphasises the change in input prices: increase in price of oil, decrease in productivity of firms (shifts LD curve to the left)
what is the key role of technological progress
- plays a key role in long-term variation in economic growth
- not the main force driving recessions
Keynesian theory
- animal spirits
- a period of heightened optimism could give way to a period of deep pessimism
- sentiments (include changes in expectations about future economic activity, changes in uncertainty facing firms and households, and fluctuations in animal spirits. Changes in sentiments lead to changes in household consumption and firm investment. Sentiments can be powerful catalysts of economic change.
- pessimist firms cut back employment and investment => household are unlikely to increase their consumption (leftward shift in LD curve) => households cut consumption => further shifting LD curve to the left]
- multiplier effect
- pessimism leads to lower spending and causes recession
animal spirits
-animal spirits are psychological factors that lead to changes in the mood of consumers or businesses, thereby affecting consumption, investment and GDP
multipliers
economic mechanisms that amplify the initial impact of shock
self-fulfilling prophecy
-situation in which the expectations of an event (such as a left shift in LD in the future) induce actions that lead to that event.
aggregate demand
Is the economy’s overall demand for GS that firms produce. Aggregate demand drives the hiring decision of firms and consequently determines the labour demand curve.
- an economy might remain in a state of extended recession, or depression because of lack of aggregate demand.
- leftward shift in LD => multipliers and self-fulfilling prophecies => consumers might not spend, afraid of running out of savings => firms won’t hire, afraid of non-spending consumers=> these forces would reinforce one-another, leaving the economy permanently on its knees
Monetary and financial factors
- contractionary monetary policy makes M2 fall sharply => price levels fall => reduces employment because of downward wage rigidity (LD to the left)
- contractionary monetary policy => real r rises => production more costly => hire less labour
- leftward shift in the supply of credit will shift firm’s LD curve to the left