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Chap10 PDF
Chap10 PDF
10
Introduction to Economic
Fluctuations
Modified for ECON 2204
by Bob Murphy
1
Facts about the business cycle
§ GDP growth averages 3–3.5 percent per year
over the long run with large fluctuations in the
short run.
§ Consumption and investment fluctuate with
GDP, but consumption tends to be less volatile
and investment more volatile than GDP.
§ Unemployment rises during recessions and falls
during expansions.
§ Okun’s law: the negative relationship between
GDP and unemployment.
CHAPTER 10 Introduction to Economic Fluctuations 2
Growth rates of real GDP, consumption
Percent 10 Real GDP
change growth rate
from 4 8
quarters Consumption
earlier growth rate
6
Average 4
growth
rate 2
-2
-4
1970 1975 1980 1985 1990 1995 2000 2005 2010 2015
Growth rates of real GDP, consump., investment
Percent
change 40 Investment
from 4 growth rate
quarters 30
earlier
20
Real GDP
10 growth rate
0
Consumption
-10 growth rate
-20
-30
1970 1975 1980 1985 1990 1995 2000 2005 2010 2015
Unemployment
Percent 12
of labor
force
10
0
1970 1975 1980 1985 1990 1995 2000 2005 2010 2015
Okun’s Law
Percentage 10 ΔY
change in 1951 1966 = 3 − 2 Δu
real GDP 8 Y
1984
6 2003
1971
4
1987
2
2001 1975
0
2009
-2 2008
1991 1982
-4
-3 -2 -1 0 1 2 3 4
Change in unemployment rate
Index of Leading Economic Indicators
§ Published monthly by the Conference Board.
§ Aims to forecast changes in economic activity
6-9 months into the future.
§ Used in planning by businesses and govt,
despite not being a perfect predictor.
80
70
60
50
40
30
20
10
Source:
0
Conference
1970 1975 1980 1985 1990 1995 2000 2005 2010
Board
Time horizons in macroeconomics
§ Long run
Prices are flexible, respond to changes in supply
or demand.
§ Short run
Many prices are “sticky” at a predetermined
level.
P
An increase in the
price level causes
a fall in real money
balances (M/P),
causing a
decrease in the
demand for goods
& services. AD
Y
P
An increase in
the money supply
shifts the AD
curve to the right.
AD2
AD1
Y
P LRAS
Y does not
depend on P,
so LRAS is
vertical.
Y
Y
= F (K , L )
CHAPTER 10 Introduction to Economic Fluctuations 19
Long-run effects of an increase in M
P LRAS
An increase
in M shifts
AD to the
right.
In the long run, P2
this raises the
price level… P1 AD2
AD1
…but leaves Y
output the same.
Y
P
The SRAS
curve is
horizontal:
The price level
is fixed at a
SRAS
predetermined P
level, and firms
sell as much as
buyers demand. Y
SRAS
P
AD2
AD1
Y
…causes Y1 Y2
output to rise.
CHAPTER 10 Introduction to Economic Fluctuations 23
From the short run to the long run
Over time, prices gradually become “unstuck.”
When they do, will they rise or fall?
In the short-run then over time,
equilibrium, if P will…
Y >Y rise
Y <Y fall
Y =Y remain constant
A = initial P LRAS
equilibrium
B = new short-
run eq’m P2 C
after Fed B SRAS
increases M P A AD2
AD1
C = long-run
equilibrium Y
Y Y2
The adverse
supply shock
moves the B SRAS2
P2
economy to
A SRAS1
point B. P1
AD1
Y
Y2 Y
34
CHAPTER SUMMARY
3. The aggregate demand curve slopes downward.
35
CHAPTER SUMMARY
6. Shocks to aggregate demand and supply cause
fluctuations in GDP and employment in the short run.
7. The Fed can attempt to stabilize the economy with
monetary policy.
36