Transcript ECONOMICS - TerpConnect

CHAPTER
Introduction to Economic Fluctuations:
Introduction to the Short-run Model
Chapter 10 - selected sections!
1
The Short Run Economic Fluctuations
– Business cycle
• real GDP fluctuates around an overall upward
trend
– Recessions
• Output declines, employment falls and
unemployment increases
– Expansions
• Output rises faster than potential output,
employment rises and unemployment falls
2
Economic Fluctuations
• Boom
– A period of time during which real GDP is
above potential GDP
• Slump
– A period during which real GDP is below
potential and/or the employment rate is
below normal (unemployment rate above
normal)
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The Business Cycle
Log-run trend in
potential GDP
Boom
Slump
Over time, real GDP fluctuates around an overall upward trend. Such
fluctuations are called business cycles. When output rises, we are in the
expansion phase of the cycle; when output falls, we are in a recession.
Potential and Actual Real GDP and Employment, quarterly,
1979–2011 (a)
5
Economic Fluctuations - Facts
• The shift from a strong expansion to a
serious recession can occur suddenly
• Recessions and the resulting slumps don’t
last forever
• The recession phase can be relatively brief
• Slumps can be long and painful
6
U.S. Employment Rate (percent employed): Workers Aged 25
to 54, 1979–2011
7
Economic Fluctuations
• Three things to explain about economic
fluctuations
– Why they occur in the first place
– Why they sometimes last so long
– Why they do not last forever
8
Can the Classical Model Explain
Economic Fluctuations?
• Remember - The Classical model is supply
oriented. Fluctuations would occur when
something affects the supply side of the
economy in the labor market, capital market
or productivity
9
Can the Classical Model Explain
Economic Fluctuations?
• Recession
– We would have to experience a sudden
leftward shift of the labor supply curve?
– Think about what this means: people
prefer to work less and the level of
employment and output would fall
10
A Recession Caused by Declining Labor Supply?
Real
Wage
Rate
Recession
Labor Supply?
G
$30
E
$25
Normal
Labor
Supply
Labor
Demand
100
90
Million Million
Employment
In fact, shifts in labor supply occur very slowly, so
they cannot explain economic fluctuations.
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Sudden shifts in the labor supply curve
are unlikely to occur
– Why would people want to work less?
– Why would unemployment increase if
people want to work less?
– Conclusion: the classical model cannot
explain fluctuations through shifts in the
supply of labor
12
Can the Classical Model Explain
Economic Fluctuations?
• Recession
– Can it be caused by a leftward shift of the
labor demand curve?
• Leftward shift in the labor demand
–
–
–
–
The level of employment would fall
The real wage rate would fall
with flexible prices the market clears.
there is no rise in unemployment
contradicting the facts of actual recessions
13
A Recession Caused by Declining Labor Demand? (a)
Real
Wage
Rate
Labor
Supply
E
$25
F
20
90
Million
Normal
Labor
Demand
Recession
Labor
Demand?
100
Million
Employment
In theory, a recession could be caused by a sudden leftward shift in the
labor demand curve, causing employment to fall. But in panel with
flexible wages, the labor market clears, so there would be no rise in
unemployment, contradicting the facts of actual recessions.
14
Sticky Wages and Leftward Shift in
Labor Demand
– With sticky wages (real wage rate remains
unchanged)
–
you get unemployment !
– this seems to fit what happens in realworld recessions
15
A Recession Caused by Declining Labor Demand? Wage
rate rigid at $25
Real
Wage
Rate
Labor
Supply
H
E
$25
20
F
80
Million
90
Million
Normal
Labor
Demand
Recession
Labor
Demand?
100
Million
What is the
level of
unemployme
nt in this
graph?
How many
people want
to work in
this graph?
Employment
Downward wage rigidity prevents the labor market from clearing. This
could, in theory, explain the rise in unemployment during a recession.
16
Are Wages Rigid and WHY?
• They seem to be.
• Institutional factors such as unions and
minimum wage.
• Employers are hesitant to lower wages negative effect on worker morale and
productivity
17
What Causes Labor Demand
to Shift Leftward?
– Decrease in labor productivity
– Decrease in total spending
18
Decrease in Labor Productivity
• Labor becomes less productive and thus
less valuable to firms
– For example, labor has less
capital(equipment) to work with
– Really need to ask why would labor
become less productive.
• Does not occur rapidly enough to
explain real-world economic fluctuations
19
Decrease in Total Spending
– Plays an important role in real-world
economic fluctuations
– But, the classical model rules this out as
an initial cause because of the flexible
price assumption and Say’s law.
20
Verdict!
• The classical model cannot explain
economic fluctuations
• Once we step away from the classical
model and the assumption that all markets
clear, a combination of a sudden drop
in spending combined with wage
rigidity can explain economic
fluctuations
21
Expansions and Recessions in the Last 50 Years
© 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
22
Expansions and Recessions in the Last 50 Years
© 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
23
Summary
• The classical model cannot explain booms
and recessions because it assumes that
markets respond very quickly to changes in
spending so that the economy remains at full
employment - labor markets always clear.
• Evidence suggests that this assumption is
not valid over short time periods - rigid wages
• The alternative view - the short-run macro
view, is that markets respond slowly to
shocks - rigidity.
24
Summary
• The major difference in these two views is
in the speed of adjustment.
• Because the short-run macro view
concentrates on the period during which
adjustment is less than complete, it
places the focus on spending.
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