Economic Fluctuations

Transcription

1 Sherif Khalifa Sherif Khalifa () Economic Fluctuations 1 / 30

2 Short-run economic fluctuations are often called business cycles. During periods of economic expansion, firms find that customers are plentiful and that profits are growing. During periods of economic contraction, firms experience declining sales and profits. Economic fluctuations do not follow a predictable pattern. Sherif Khalifa () Economic Fluctuations 2 / 30

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6 Economic Fluctuations Sherif Khalifa () Economic Fluctuations 6 / 30

7 Unemployment rate, percent of of labor force Sherif Khalifa () Economic Fluctuations 7 / 30

8 Economic Fluctuations Sherif Khalifa () Economic Fluctuations 8 / 30

9 AS/AD is the model that explains short run fluctuations in economic activity around its long run trend. The aggregate demand curve is a curve that shows the quantity of goods and services that households, firms, the government, and foreigners want to buy at each price level. The aggregate supply curve is a curve that shows the quantity of goods and services that firms choose to produce and sell at each price level. The price level and the quantity of output adjust to bring aggregate demand and aggregate supply into balance. Sherif Khalifa () Economic Fluctuations 9 / 30

10 Aggregate Demand P P 1 P 2 AD Y Y 1 Y 2 Sherif Khalifa () Economic Fluctuations 10 / 30

11 Aggregate Demand Wealth Effect A decrease in the price level increases the value of money and makes consumers wealthier. This in turn encourages them to spend more, which means larger quantity of goods and services demanded. An increase in the price level decreases the value of money, and makes consumers less wealthy. This in turn discourages them from spending, which means smaller quantity of goods and services demanded. Sherif Khalifa () Economic Fluctuations 11 / 30

12 Aggregate Demand Interest Rate Effect The lower the price level, the less money households need to hold to buy the goods and services they want. As households try to convert some of their excess money into interest bearing assets, they decrease interest rates. The decrease in the interest rate, encourages spending on investment goods and increases the quantity of goods and services demanded. The higher the price level, the more money households need to hold to buy the goods and services they want. As households try to withdraw some of their money in interest bearing assets, they increase interest rates. The increase in the interest rate, discourages spending on investment goods and decreases the quantity of goods and services demanded. Sherif Khalifa () Economic Fluctuations 12 / 30

13 Aggregate Demand Exchange Rate Effect When a decrease in the U.S. price level causes U.S. interest rates to decrease, the value of the dollar decreases. This depreciation increases U.S. net exports and the quantity of goods and services demanded. When an increase in the U.S. price level causes U.S. interest rates to increase, the value of the dollar increases. This appreciation decreases U.S. net exports and the quantity of goods and services demanded. Sherif Khalifa () Economic Fluctuations 13 / 30

14 Aggregate Demand Consumption spending: any event that changes how much people want to consume at a given price level shifts the AD curve. Investment spending: any event that changes how much firms want to invest at a given price level shifts the AD curve. Government spending: the most direct way that policymakers shift the AD curve is through government spending. Net Exports: any event that changes net exports for a given price level shifts the AD curve. Sherif Khalifa () Economic Fluctuations 14 / 30

15 Aggregate Supply In the long run, an economy s production of goods and services depends on its supplies of labor, capital, natural resources and available technology. Natural rate of output is the production of goods and services that an economy achieves in the long run when unemployment is at its natural rate. Natural rate of output depends on the economy s stocks of labor, capital, natural resources, and the level of technology. An increase in the price level does not affect any of these factors, so it does not affect the natural rate of output. Any event that changes any of the determinants of the natural rate of output will shift LRAS. Sherif Khalifa () Economic Fluctuations 15 / 30

16 Aggregate Supply P LRAS P 1 P 2 Y N Sherif Khalifa () Economic Fluctuations 16 / 30 Y

17 Aggregate Supply The quantity of output supplied deviates from its long run, or natural level, when the actual price level in the economy deviates from the price level that people expected to prevail. Y = Y + a (P EP) P When P > P E SRAS the expected price level P E When P < P E Y N Sherif Khalifa () Economic Fluctuations 17 / 30 Y

18 Aggregate Supply P SRAS P 2 P 1 Y 1 Y 2 Y Sherif Khalifa () Economic Fluctuations 18 / 30

19 Aggregate Supply The Sticky Wage Theory Nominal wages are slow to adjust to changing economic conditions, due to long term contracts between workers and firms. A firm expects the price level to be high, and signed a contract with its workers to pay them a high wage. The price level turns out to be lower than expected, but the cost of labor is stuck at the contracted level. Production is now less profitable, so the firm hires fewer workers and decreases the quantities of output supplied. Sherif Khalifa () Economic Fluctuations 19 / 30

20 Aggregate Supply The Sticky Price Theory The prices of some goods and services adjust sluggishly due to menu costs. Firms announce their prices in advance based on economic conditions it expects to prevail over the coming year. The economy experiences an unexpected contraction of money supply, which decreases the overall price level in the long run. Although some firms can decrease their prices immediately, others may not want to incur menu costs. Because these firms have prices that are too high, their sales decline. Declining sales cause these firms to cut back on production and employment. Sherif Khalifa () Economic Fluctuations 20 / 30

21 Aggregate Supply All the variables that shift the LRAS causes a shift in the SRAS plus the price level that people expect to prevail. An increase in the expected price level decreases the quantity of goods and services supplied and shifts the SRAS to the left. A decrease in the expected price level increases the quantity of goods and services supplied and shifts the SRAS to the right. Sherif Khalifa () Economic Fluctuations 21 / 30

22 P LRAS 1 SRAS 1 P 1 Y N AD 1 Y Sherif Khalifa () Economic Fluctuations 22 / 30

23 Event: a wave of pessimism overtakes the economy. P LRAS 1 SRAS 1 P 1 P 2 AD 1 Y 2 Y N AD 2 Y Sherif Khalifa () Economic Fluctuations 23 / 30

24 The wave of pessimism affect spending plans, and shifts the aggregate demand curve to the left causing a recession and a decline in prices. Pessimism about the future is self fulfilling,and leads to falling incomes and increasing unemployment. The price level is below the level that people had come to expect before the sudden fall in aggregate demand. Overtime, expectations catch up with this new reality, and the fall in the expected price alters wages, prices and perceptions. Workers and firms bargain for lower wages, which encourages more hiring and expands production which shifts the SRAS to the right. Sherif Khalifa () Economic Fluctuations 24 / 30

25 P LRAS 1 SRAS 1 SRAS 2 P 1 P 2 AD 1 Y 2 Y N AD 2 Y Sherif Khalifa () Economic Fluctuations 25 / 30

26 P LRAS 1 SRAS 1 P 1 P 2 AD 1 Y 2 Y N AD 2 Y Sherif Khalifa () Economic Fluctuations 26 / 30

27 Event: a war interrupting the shipping of crude oil. P LRAS 1 SRAS 2 SRAS 1 P 2 P 1 Y 2 Y N AD 1 Y Sherif Khalifa () Economic Fluctuations 27 / 30

28 Because higher production costs make selling goods and services less profitable, firms supply a smaller quantity of output for any given price level. This causes a stagflation, which is a period of falling output and increasing prices. Stagflation is a combination of stagnation and inflation. The low level of output and employment will put downward pressure on workers wages because workers have less bargaining power when unemployment is high. As nominal wages fall, producing goods and services become profitable, and the SRAS shifts to the right. Sherif Khalifa () Economic Fluctuations 28 / 30

29 P LRAS 1 SRAS 2 SRAS 1 P 2 P 1 AD 1 Y 2 Y N Y Sherif Khalifa () Economic Fluctuations 29 / 30

30 P LRAS 1 SRAS 2 SRAS 1 P 3 P 2 P 1 AD 2 AD 1 Y 2 Y N Y Sherif Khalifa () Economic Fluctuations 30 / 30