MACROECONOMICSMACROECONOMICS

Chapter 9Chapter 9

Introduction to Economic Introduction to Economic FluctuationsFluctuations

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Short Run FluctuationsShort Run Fluctuations

What causes them?What causes them?Can policymakers avoid recessions?Can policymakers avoid recessions?Plan of the chapterPlan of the chapter

Data describing short run fluctuationsData describing short run fluctuationsDifference between long run and short runDifference between long run and short runThe basic model of AS-ADThe basic model of AS-AD

33Figure 9.1 Real GDP Growth in the United StatesMankiw: Macroeconomics, Seventh EditionCopyright © 2010 by Worth Publishers

44www.nber.org

55Figure 9.2 Growth in Consumption and InvestmentMankiw: Macroeconomics, Seventh EditionCopyright © 2010 by Worth Publishers

Investments are much more volatile than consumption expenditures.

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http://data.bls.gov/pdq/SurveyOutputServlet?data_tool=latest_numbers&series_id=LNS14000000

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Okun’s LawOkun’s Law%Δ in Y = 3% - 2(Change in Unemployment Rate from one year to another)

Sep 08 to Sep 09 unemployment went from 6.2% to 9.8%, 3.6% increase. Predicted change in Y will be -4.2%

88http://www.econ.yale.edu/alumni/conf2011/shiller-presentation.pdf

99

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Why Different Time Horizons?Why Different Time Horizons?

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Why Different Time Horizons?Why Different Time Horizons?

In the long run prices are flexible; In the long run prices are flexible; complete adjustment.complete adjustment.Money neutrality: changes in money supply Money neutrality: changes in money supply

does not affect real variables.does not affect real variables. In the short run prices are sticky.In the short run prices are sticky.

Real variables do respond to money in te Real variables do respond to money in te short run.short run.

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Long RunLong Run

In the long run, Y is determined with K, L, and In the long run, Y is determined with K, L, and technology.technology.

In the long run all the resources are fully In the long run all the resources are fully employed.employed.

The long run Y is thus fixed.The long run Y is thus fixed. The circular flow is in equilibrium because any The circular flow is in equilibrium because any

shock is dealt with price adjustment.shock is dealt with price adjustment. How do you show the supply of output (Y) in a How do you show the supply of output (Y) in a

diagram where Y is the horizontal axis?diagram where Y is the horizontal axis?

1313Figure 9.7 The Long-Run Aggregate Supply CurveMankiw: Macroeconomics, Seventh EditionCopyright © 2010 by Worth Publishers

1414

Aggregate DemandAggregate Demand

If money supply and velocity were given If money supply and velocity were given (fixed), then any change in the price level (fixed), then any change in the price level will have to be compensated by a change will have to be compensated by a change in Y to keep the nominal GDP fixed.in Y to keep the nominal GDP fixed.

What happens to the AD, ifWhat happens to the AD, ifMoney supply increases?Money supply increases?Money supply decreases?Money supply decreases?Velocity increases (money demand Velocity increases (money demand

decreases)?decreases)?

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Velocity increase will bring an outward shift.Money demand increase will bring an inward shift.Our aggregate demand theory will include all the expenditures by consumers, businesses, government, and the rest of the world in future chapters.

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Long Run AdjustmentLong Run Adjustment

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Short RunShort Run

Suppose no prices adjust in the short run; Suppose no prices adjust in the short run; and when they do start to adjust, all the and when they do start to adjust, all the prices adjust slowly, together.prices adjust slowly, together.

What will the short run aggregate supply What will the short run aggregate supply curve look like this year? Next year?curve look like this year? Next year?

How will the economy react in the short How will the economy react in the short run to a shift in AD?run to a shift in AD?The equilibrium in the circular flow model is The equilibrium in the circular flow model is

now achieved through output adjustment.now achieved through output adjustment.

1818Figure 9.9 The Short-Run Aggregate Supply CurveMankiw: Macroeconomics, Seventh EditionCopyright © 2010 by Worth Publishers

1919Figure 9.10 Shifts in Aggregate Demand in the Short RunMankiw: Macroeconomics, Seventh EditionCopyright © 2010 by Worth Publishers

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Long and Short Run EquilibriumLong and Short Run Equilibrium

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From SR to LRFrom SR to LR

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From SR to LRFrom SR to LR

There may be many reasons for an aggregate demand increase. The model in this chapter will allow us to either increase the velocity of money or increase the money supply. Either one will shift the AD to the right.

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An Adverse Supply ShockAn Adverse Supply ShockA general increase in union negotiated wages; sudden increase in the prices of widely used inputs; regulation that adds up to costs; crop failure…

STAGFLATION initially but back at the starting point in the long run.

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Accommodating an Adverse ShockAccommodating an Adverse Shock

No unemployment increase but permanent increase in the price level.