Business Cycles (definition)
short-run economic fluctuations around the long-run trend of the economy
period of declining real GDP and rising unemployment
Four basic facts about Business CYcles
1) Business cycles are irregular and hard to predict. 2) Most macroeconomic quantities fluctuate together.3) Some macroeconomic variables fluctuate more than others. (investment fluctuates more than real GDP, and real GDP fluctuates more than consumption). 4) As output falls, unemployment rises.
Real Business Cycle Theory
Business cycles are due to the fact that technological progress is sometimes faster and sometimes slower.
Business cycles are due to the fact that prices do not immediately adjust to changes in the economic environment
Aggregate Demand Curve
shows the quantity of goods and services that households, firms, the government, and abroad costumers want to buy at each price level.
Aggregate supply curve
shows the quantity of goods and services that firms in the country choose to produce and sell at each price level
What is y axis in the aggregate demand and supply graph? What is x axis?
Y axis is price level which is the CPI or the GDP deflator. X axis is quantity of output or real GDP
Why does the aggregate-demand curve slope down? In other words, why does a decrease in price level increase the quantity of goods and services demanded?
The wealth effect. The interest-rate effect. The exchange rate effect.
the wealth effect
How a Change in the Price Level effects Consumption. A decrease in the price level raises the real value of money and makes consumers wealthier, which encourages them to spend more. This increase in spending leads to a larger number of goods demanded.
the interest-rate effect
A lower price level reduces the interest rate and encourages greater spending on investment goods. This increases the quantity of goods and services demanded.
The exchange rate effect
When a fall in U.S. price level causes U.S. interest rates to fall, the real value of the dollar declines in foreign exchange markets. This depreciation stimulates U.S. net exports and thereby increases the quantity of goods and services demanded.
What happens when price level falls?
Consumers are wealthier so demand for goods increases. Interest rates fall so demand for investment goods increases. Currency depreciates so demand for net exports increases.
What can shift the Aggregate demand curve?
Changes in consumption (lower tax-people want to spend more-curve shifts to the right). Changes in investment (tax benefit for investing-curve shifts right). Government purchases (Congress decides to limit purchases of guns-quantity demanded decreases- demand shifts left). Changes in net exports (Europe has a recession-they buy less US goods- Agg demand goes left).
What does the aggregate supply curve look like in the long run? in the short run?
Long run aggregate-supply curve is vertical. Short run aggregate supply curve slopes upward.
Why is the aggregate supply curve vertical in the long run?
In the long run, the production of goods and services in a economy is determined by the supplies of labor, capital and natural resources, and by the technology. Price level does not affect these determinants
Why might the aggregate long run supply curve shift?
A change in the natural rate of output
Why does the aggregate supply curve slope upward in the long run?
sticky-wage theory. sticky-price theory. misperception theory. All three theories are based on the idea that actual price level differs from the expected price level.
Sticky wage theory
Short run aggregate-supply curve slopes upward because nominal WAGES are slow to adjust to changing price levels.
Prices take a while to adjust to new price levels. Think about menu costs
an unexpectedly LOW price level leads some suppliers to think their relative prices have FALLEN which induces a FALL in production
What happens when there is a decrease in Aggregate demand?
A decrease in aggregate demand (a shift to the left) causes output (GDP) to fall in the short-run. Over time, the short run aggregate supply curve shifts to the right and output returns to its natural rate.
What happens when there is a decrease in short run Aggregate supply? What is this called? What happens if policy makers step in?
A decrease in short run aggregate supply causes output to fall and the price level to rise. This is called stagflation. Policy makers will expand aggregate demand, price level will rise further, but output will go back to its natural rate (where the long run aggregate supply line is). This exaggerates inflation.