Transcript Mankiw 6e PowerPoints
N. Gregory Mankiw
Macroeconomics
Sixth Edition Chapter 9:
Introduction to Economic Fluctuations
CHAPTER 9
Introduction to Economic Fluctuations
Econ 4020/Chatterjee
slide 0
In this chapter, you will learn…
facts about the business cycle how the short run differs from the long run an introduction to aggregate demand an introduction to aggregate supply in the short run and long run how the model of aggregate demand and aggregate supply can be used to analyze the short-run and long run effects of “shocks.”
CHAPTER 9
Introduction to Economic Fluctuations slide 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 9
Introduction to Economic Fluctuations slide 2
Growth rates of real GDP, consumption
Percent change from 4 quarters earlier 10 8 6
Real GDP growth rate Consumption growth rate Average growth rate
4 2 0 -2 -4 1970 1975 1980 1985 1990 1995 2000 2005
Growth rates of real GDP, consumption, investment
Percent change from 4 quarters earlier 40 30 20
Investment growth rate
10
Real GDP growth rate
0 -10 -20
Consumption growth rate
-30 1970 1975 1980 1985 1990 1995 2000 2005
Unemployment
Percent of labor force 12 10 8 6 4 2 0 1970 1975 1980 1985 1990 1995 2000 2005
Okun’s Law
Percentage change in real GDP 10 8 6 4 2 0 -2 -4 -3
1984 1951 1987
-2 -1
1966 2001
Y
1991
Y
2003
3.5
1982
2
u
1975
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.
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Introduction to Economic Fluctuations slide 7
Components of the LEI index
Average workweek in manufacturing Initial weekly claims for unemployment insurance New orders for consumer goods and materials New orders, non-defense capital goods Vendor performance New building permits issued Index of stock prices
M2
Yield spread (10-year minus 3-month) on Treasuries Index of consumer expectations
CHAPTER 9
Introduction to Economic Fluctuations slide 8
Index of Leading Economic Indicators
160 140 120 100 80 60 40 20
Source: Conference Board
0 1970 1975 1980 1985 1990 1995 2000 2005
Time horizons in macroeconomics
Long run: Prices are flexible, respond to changes in supply or demand.
Short run: Many prices are “sticky” at some predetermined level.
The economy behaves much differently when prices are sticky.
CHAPTER 9
Introduction to Economic Fluctuations slide 10
Recap of classical macro theory
(Chaps. 3-8)
Output is determined by the supply side: supplies of capital, labor technology.
Changes in demand for goods & services (
C
,
I
,
G
) only affect prices, not quantities.
Assumes complete price flexibility. Applies to the long run.
CHAPTER 9
Introduction to Economic Fluctuations slide 11
When prices are sticky…
…output and employment also depend on demand, which is affected by fiscal policy (
G
and
T
monetary policy (
M
) ) other factors, like exogenous changes in
C
or
I
.
CHAPTER 9
Introduction to Economic Fluctuations slide 12
The model of aggregate demand and supply
the paradigm most mainstream economists and policymakers use to think about economic fluctuations and policies to stabilize the economy shows how the price level and aggregate output are determined shows how the economy’s behavior is different in the short run and long run
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Introduction to Economic Fluctuations slide 13
Aggregate demand
The aggregate demand curve shows the relationship between the price level and the quantity of output demanded. For this chapter’s intro to the
AD/AS
model, we use a simple theory of aggregate demand based on the quantity theory of money. Chapters 10-12 develop the theory of aggregate demand in more detail.
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Introduction to Economic Fluctuations slide 14
The Quantity Equation as Aggregate Demand
From Chapter 4, recall the quantity equation
M V
=
P Y
For given values of
M
and
V
, this equation implies an inverse relationship between
P
and
Y
:
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Introduction to Economic Fluctuations slide 15
The downward-sloping AD curve
An increase in the price level causes a fall in real money balances (
M/P
), causing a decrease in the demand for goods & services.
P
AD
Y CHAPTER 9
Introduction to Economic Fluctuations slide 16
Shifting the AD curve
P
An increase in the money supply shifts the
AD
curve to the right.
CHAPTER 9
Introduction to Economic Fluctuations AD 1 AD 2
Y
slide 17
Aggregate supply in the long run
Recall from Chapter 3: In the long run, output is determined by factor supplies and technology
Y
( ) Y
is the
full-employment
or
natural
level of output, the level of output at which the economy’s resources are fully employed.
“Full employment” means that unemployment equals its natural rate (not zero).
CHAPTER 9
Introduction to Economic Fluctuations slide 18
The long-run aggregate supply curve
P
LRAS
Y
does not depend on
P
, so
LRAS
is vertical.
CHAPTER 9
( Y
,
)
Introduction to Economic Fluctuations
Y
slide 19
Long-run effects of an increase in M
P
LRAS An increase in
M
shifts
AD
to the right. In the long run, this raises the price level…
P
2
P
1 AD 1 AD 2
Y
…but leaves output the same.
Y CHAPTER 9
Introduction to Economic Fluctuations slide 20
Aggregate supply in the short run
Many prices are sticky in the short run. For now (and through Chap. 12), we assume all prices are stuck at a predetermined level in the short run.
firms are willing to sell as much at that price level as their customers are willing to buy. Therefore, the short-run aggregate supply (
SRAS
) curve is horizontal:
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Introduction to Economic Fluctuations slide 21
The short-run aggregate supply curve
P
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 CHAPTER 9
Introduction to Economic Fluctuations slide 22
Short-run effects of an increase in M
P
In the short run when prices are sticky,… …an increase in aggregate demand…
P
…causes output to rise.
Y
1
CHAPTER 9
Introduction to Economic Fluctuations
Y
2 SRAS AD 2 AD 1
Y
slide 23
The SR & LR effects of
M
> 0 A = initial equilibrium
P
LRAS B = new short run eq’m after Fed increases
M
C = long-run equilibrium
P
2
P
A
Y
C
CHAPTER 9
Introduction to Economic Fluctuations B
Y
2 SRAS AD 2 AD 1
Y
slide 25
The effects of a negative demand shock
AD
shifts left, depressing output and employment in the short run.
P
LRAS Over time, prices fall and the economy moves down its demand curve toward full employment.
CHAPTER 9 P P
2 B
Y
2
Y
A C Introduction to Economic Fluctuations SRAS AD 2 AD 1
Y
slide 27
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.
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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.
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CASE STUDY:
The 1970s oil shocks
The oil price shock shifts
SRAS
up, causing output and employment to fall.
P
LRAS
P
2 B In absence of further price shocks, prices will fall over time and economy moves back toward full employment.
P
1
Y
2
Y CHAPTER 9
Introduction to Economic Fluctuations SRAS 2 AD SRAS 1
Y
slide 30
CASE STUDY:
The 1970s oil shocks
70% Predicted effects of the oil shock: • inflation • • output unemployment 60% 50% 40% 30% 20% …and then a gradual recovery.
10% 0% 1973 1974 1975 1976 12% 10% 8% 6% 1977 4%
CHAPTER 9
Change in oil prices (left scale) Inflation rate-CPI (right scale) Unemployment rate (right scale) Introduction to Economic Fluctuations slide 31
CASE STUDY:
The 1970s oil shocks
60% Late 1970s: As economy was recovering, oil prices shot up again, causing another huge supply shock!!!
50% 40% 30% 20% 10% 0% 1977 1978 1979 1980 14% 12% 10% 8% 6% 1981 4%
CHAPTER 9
Change in oil prices (left scale) Inflation rate-CPI (right scale) Unemployment rate (right scale) Introduction to Economic Fluctuations slide 32
1980s:
CASE STUDY:
The 1980s oil shocks
40% 30% 20% A favorable supply shock- a significant fall in oil prices. 10% 0% -10% -20% As the model predicts, inflation and unemployment fell: -30% -40% -50% 1982 1983 1984 1985 1986 Change in oil prices (left scale)
CHAPTER 9
Inflation rate-CPI (right scale) Unemployment rate (right scale) Introduction to Economic Fluctuations 10% 8% 6% 4% 2% 1987 0% slide 33
Stabilization policy
def: policy actions aimed at reducing the severity of short-run economic fluctuations.
Example: Using monetary policy to combat the effects of adverse supply shocks:
CHAPTER 9
Introduction to Economic Fluctuations slide 34
Stabilizing output with monetary policy
P
LRAS The adverse supply shock moves the economy to point B.
P
2
P
1 B A
Y
2
Y CHAPTER 9
Introduction to Economic Fluctuations SRAS 2 AD 1 SRAS 1
Y
slide 35
Stabilizing output with monetary policy
P
LRAS But the Fed accommodates the shock by raising agg. demand.
P
2 B C
P
1 A results:
P
is permanently higher, but
Y
remains at its full employment level.
Y
2
Y CHAPTER 9
Introduction to Economic Fluctuations SRAS 2 AD 1 AD 2
Y
slide 36
Chapter Summary
1.
Long run: prices are flexible, output and employment are always at their natural rates, and the classical theory applies.
Short run: prices are sticky, shocks can push output and employment away from their natural rates. 2.
Aggregate demand and supply: a framework to analyze economic fluctuations
CHAPTER 9
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Chapter Summary
3. The aggregate demand curve slopes downward.
4. The long-run aggregate supply curve is vertical, because output depends on technology and factor supplies, but not prices.
5. The short-run aggregate supply curve is horizontal, because prices are sticky at predetermined levels.
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Introduction to Economic Fluctuations slide 38
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.
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