Transcript Mankiw 6e PowerPoints

Macroeconomics & The Global
Economy
Ace Institute of Management
Chapter 9: Economic Fluctuation
(Business Cycle Theory)
Instructor
Sandeep Basnyat
[email protected]
9841 892281
Introduction
 Continual ups and downs in the rate of growth of national
income
 Business cycle is the alternating periods of expanding and
contracting economic activity.
Growth rates of real GDP, consumption
Percent
change
from 4
quarters
earlier
Average
growth
rate
Real GDP
growth rate
Consumption
growth rate
Growth rates of real GDP, consumption, investment
Percent
change
from 4
quarters
earlier
Investment
growth rate
Real GDP
growth rate
Consumption
growth rate
Unemployment
Percent
of labor
force
Phases of Business Cycle
Output
 There are four phases of business cycle
 Prosperity or Boom
 Recession
 Depression or Slump
 Recovery or Revival
Periods
Why does this happen? What are its
implications to an economy?
 Different behavior of Price in short and long run
 Demand and supply shocks
Behaviour of Price
 Short run
Many prices are “sticky” at a predetermined
level.
 Long run
Prices are flexible, respond to changes in
supply or demand.
The economy behaves much differently
when prices are sticky than flexible.
Aggregate demand
 The aggregate demand curve shows the
relationship between the price level and the
quantity of output demanded.
 Also. from quantity equation
MV = PY
 If M and V are constant then,
this equation implies an inverse relationship
between P and Y causing downward
sloping AD curve
The downward-sloping AD curve
P
AD
Y
Shifting the AD curve
P
An increase in
the money
supply shifts the
AD curve to the
right.
AD2
AD1
Y
The short-run aggregate supply curve
The SRAS
curve is
horizontal:
The price level
is fixed at a
predetermined
level, and firms
sell as much as
buyers demand.
P
SRAS
Y
The long-run aggregate supply curve
P
has
enough time
to respond to
fixed K,L:
does not
depend on P,
so LRAS is
vertical.
LRAS
Increase in
price is
followed by
increase in
cost and
suppliers do
not have
incentives to
increase
supply
Y
The Aggregate Demand and supply curves
P
LRAS
SRAS
AD
Y
From short run to Long run
In the short run
when prices are
sticky,…
P
…an increase
in aggregate
demand…
SRAS
AD2
AD1
…causes output
to rise.
Y1
Y2
Y
Short-run effects of an increase in M
A = initial
equilibrium
P
LRAS
B = new short-run
eq’m after
Central Bank
increases M
C = long-run
equilibrium
C
B
A
Y2
SRAS
AD2
AD1
Y
Long-run effects of an increase in M
P
Net Effect
Short run and
long run effects
of price cause
business cycle
LRAS
P2
P1
AD2
AD1
Y
How shocking!!!
 shocks: exogenous changes in agg. supply or
demand
 Shocks temporarily push the economy away from
full employment.
CHAPTER 9
Introduction to Economic Fluctuations
18
The effects of a negative demand shock
AD shifts left,
depressing
output and
employment
in the short run.
Over time,
prices fall and
the economy
moves down its
demand curve
toward fullemployment.
CHAPTER 9
P
LRAS
B
A
C
P2
SRAS
AD1
AD2
Y2
Introduction to Economic Fluctuations
Y
19
Supply shocks
 A supply shock alters production costs, affects the
prices that firms charge. (also called price shocks)
 Examples of adverse supply shocks:
 Bad weather reduces crop yields, pushing up
food prices.
 Workers unionize, negotiate wage increases.
 New environmental regulations require firms to
reduce emissions. Firms charge higher prices to
help cover the costs of compliance.
 Favorable supply shocks lower costs and prices.
CHAPTER 9
Introduction to Economic Fluctuations
20
CASE STUDY:
The 1970s oil shocks
 Early 1970s: OPEC coordinates a reduction in
the supply of oil.
 Oil prices rose
11% in 1973
68% in 1974
16% in 1975
 Such sharp oil price increases are supply
shocks because they significantly impact
production costs and prices.
CHAPTER 9
Introduction to Economic Fluctuations
21
CASE STUDY:
The 1970s oil shocks
The oil price shock
shifts SRAS up,
causing output and
employment to fall.
In absence of
further price
shocks, prices will
fall over time and
economy moves
back toward full
employment.
CHAPTER 9
P
LRAS
B
SRAS2
A
SRAS1
AD
Y2
Introduction to Economic Fluctuations
Y
22
Thank You
23