Transcript Diapositiva 1

BUSINESS CYCLE
by
Caterina Ficiarà
An economic system is characterized by
fluctuations.
In some years, the production of goods and
services rises and this growth allows everyone
to enjoy a higher standard of living.
But in some years, firms are unable to sell all
the goods they produce and this causes
unemployment and the real GDP and other
measures of income fall.
So we have:
- recession; a period of falling incomes and
rising unemployment
- depression; a severe recession
Fluctuations in the economy are also called
“business cycle”.
This is a word that could create
misunderstandings, because it seems to
suggest that economic fluctuations follow a
regular,predictable pattern (and it’s obvious
that is not like that).
Studying changes that come out during a shortrun, we can see that the variable mostly used
is the real GDP (= gross domestic product,
known with the word “PIL” in Italy).
GDP measures the value of all final goods
produced within a given period.
In Italy the GDP is declining year by year and
this is related to the economic crysis that
affectes the whole world.
Anyway, many macroeconomic variables that
measure some type of income, spending, or
production fluctuate together. When real
GDP falls in a recession, the same happens
to personal income, corporate profits,
consumer spending, investment spending,
industrial production.
When the real GDP falls, this affects the
utilization of labor force and in this way the
uneployment rises.
This happens because firms decide to produce
a smaller quantity of goods (they do not
require a high level of labor force to do it)
The basic model of a short-run economic
fluctuations focuses on two variables:
- The economy’s output of good and
services,that is measured by the real GDP (as
we said previously)
- The overall price level, that is measured by
the GDP deflator ( nominal GDP / real GDP X
100 )
Moreover, we analyze fluctuations in the economy
as a whole with the model of the aggregate demand
and aggregate supply.
The aggregate-demand curve shows the
quantity of goods and services that people, firms
and the government want to buy at each price level.
The aggregate-supply curve shows the quantity of
goods and services that firms produce and sell at
each price level.
According to this model, the price level and the
quantity of output adjust in order to balance
aggregate demand and aggregate supply.
Price level
Aggregate supply curve
Equilibrium
price level
Aggregate demand curve
Equilibrium output
Quantity of output
The aggregate-demand curve talks about the
quantity of all goods and services demanded
in the economy at any given price level.
Ceteris paribus, a fall in the economy’s
overall level of prices tends to raise the
quantity of goods and services demanded.
We have to recall the components of GDP,
that are consumption, investment, the
expenditure of public sector and net
exports.
There are three different but related reasons which
explain why a fall in the price level increases the
quantity of goods and services demanded:
- Consumers are encouraged to spend more, which
stimulates the demand for consumption goods.
- Interest rates fall, which stimulates the demand for
investment goods.
- The exchange rate depreciates, which stimulates
the demand for net exports.
So a fall in the level of prices has the effect to
stimulate the increase of these components, which
means a larger quantity of goods and services
demanded. This is why the aggregate demand curve
slopes downward.
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-
But many other factors affect the quantity of goods
and services demanded at a given price level. When
one of these other factors changes, the aggregatedemand curve shifts.
So we have:
Shifts caused from consumption (the quantity of
goods demanded by the consumers)
Shifts caused from investment (how much firms
want to invest)
Shifts caused from Government Purchases
Shifts caused from Net export (if a country is in
recession, it buyes a fewer quantity of goods from
foreign countries)
The aggregate-supply curve talks about the
total quantity of goods and services that
firms produce and sell at any given price
level.
In the long run, the aggregate-supply curve
is vertical (it depends on the quantities of
labor,capital,natural resourses and
technology) instead, in the short run, the
aggregate-supply curve slopes upward
(instead of the aggregate demand curve,
which is downward sloping).
The long-run aggregate supply curve is vertical
at the so-called nature rate of output, that is
the level of production reached by the
economy in a long-run analysis.
-
-
-
In the long run, even the aggregate-supply curve
can shift.
Shifts caused from Labor (a greater number of
workers increases the production of goods)
Shifts caused from Capital (an increase in the
capital stock increases the productivity and,in this
way, the quantity of goods supplied)
Shifts caused from Natural Resources (for example,
a discovery of a new mineral deposit)
Shifts caused from Technological Knowledge (for
example, the industrial revolution)
We said the aggregate supply curve slopes
upward in the short-run.
There many theories which try to explain it:
- The misperceptions theory; a lower price
level creates misperception about relative
prices (which are the prices of those goods
compared to other prices), which induces
firms to decrease their production of goods
- The sticky-wage theory; wages do not
immediatly adjust to the price level, a lower
price level makes employment and
production less profitable,which induces
firms to reduce their quantity of goods
- The sticky-price theory; not all the prices
adjust immediatly when the conditions
change and this creates an unexpected fall of
the price,which induces firms,that want to
reach a higher price level, to reduce their
quantity of goods.
A contraction of the aggregate demand curve
has different effects.
- If we are in the short-run, it affects the
production of outputs,causing fluctuations
- If we are in the long-run, it affects the overall
price level (and not the level of outputs
produced)
Ex. Great depression of 1929
In this period, in the USA, the real GDP fell by 27
percent and the unemployment (which is strictly
related to the level of the production) rose from 3
percent to 25 percent. But what caused this big
contraction of the aggregate-demand curve?
Many economists think the reason was the decline
in the money supply, due to problems in the
banking system. Other economists suggest this
collapse in the aggregate-demand was related to
the fact that stock prices fell, depressing
consumers.
And what about the aggregate supply curve’s
shift?
It could create the so-called stagflation,which
means a period of falling output and rising
prices.
Ex. Suez Channel crysis
To sum up, one possible reason of fluctuations
(= also known with the term “business
cycle”) is related to shifts of the aggregate
demand curve, instead the other one is
related to shifts of the aggregate supply
curve.