INTRODUCTION TO ECONOMIC FLUCTUATIONS

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ECON 2003MACROECONOMICS

• CHAPTER 9
• INTRODUCTION TO ECONOMIC FLUCTUATIONS

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• Recessions periods of falling incomes and rising
  unemployment
• Business cycle short run fluctuations in outut
  and employment
• Short run fluctuations

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TIME HORIZONS IN MACROECONOMICS

• Classical theory applies to the long run, not the
  short run.
• The key difference between short run and long run
  is the behaviour of prices.
• In the long run, output and velocity of money are
  fixed a change in the money supply affects
  directly prices.

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• In short run, prices are not fully flexible thus
  a change in the money supply may affect output
  and employment.
• Economic fluctuations short run price
  stickiness
• classical dichotomy no longer holds
  nominal variables affect real variables.

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Model of AS and AD

• Flexible prices are crucial for the classical
  theory.
• When prices are sticky, output depends on the
  demand for goods and services.
• Because monetary and fiscal policies can
  influence the economys output over the time
  horizon when prices are sticky, there is a
  rationale for why these policies may be useful in
  stabilizing the economy in the short run.

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• Short run prices are sticky capital and labor
  are sometimes not fully employed.
• Long run classical model prices are flexible
  capital and labor are fully employed.
• Very long run basic theory of economic growth,
  cpital stock, labor force and technology can
  change.

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AGGREGATE DEMAND

• Aggregate demand is the relationship between
  quantity of output demanded and aggregate price
  level.
• The quantity equation as aggregate demand
• MV PY
• M/P kY
• For any fixed money supply and velocity, the
  quantity equation yields a negative relationship
  between P and Y.

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• Once PY is fixed, if P goes up, Y must go down.
• The aggregate demand curve is drawn for a fixed
  value of the money supply.
• If the money supply changes, the aggregate demand
  shifts.
• If the velocity of money changes, the aggregate
  demand shifts.

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AGGREGATE SUPPLY

• Aggregate supply is the relationship between the
  quantity of goods and services supplied and the
  price level.
• The long run the vertical aggregate supply curve
• According to the classical model, output doesnot
  depend on the price level.
• The verical AS curve satisfies the classical
  dichotomy output is at its full-employment or
  natural level.

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• The short run the horizontal aggregate supply
  curve
• Some prices are sticky and donot adjust to
  changes in demand.
• Changes in aggregate demand affet the level of
  output.
• From short run to the long run
• Long run equilibrium is where short run AS, long
  run AS and AD intersect.
• Changes in aggregate demand affect the level of
  output in short run but return to the long run
  level .

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STABILIZATION POLICY

• Exogenous changes in AS or AD are called shocks
  to the economy.
• Shocks to AD demand shock
• Shocks to AS supply shock
• One goal of the AS and AD model is to show how
  shocks cause economic fluctuations.
• Another goal of the model is to evaluate how
  macroeconomic policy can respond to these
  shocks stabilization policy