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Macroeconomics: Introduction To Economic Fluctuations

Research methods

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64 views

Macroeconomics: Introduction To Economic Fluctuations

Research methods

Uploaded by

nazia nazia
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as PPTX, PDF, TXT or read online on Scribd
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Macroeconomics

N. Gregory Mankiw

Introduction to
Economic
Fluctuations

Presentation Slides

© 2019 Worth Publishers, all rights reserved


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 in
the 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.”
3 The
CHAPTER 10
1 National
Introduction
Science
Income
of Macroeconomics
to Economic Fluctuations
Facts about the business cycle

• GDP growth averages 3–3.5% 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
Growth rates of real GDP, consumption
Growth rates of real GDP, consump., investment

Percent
change from
4 quarters
earlier
Unemployment
Okun’s law
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 government, despite
not being a perfect predictor.
Components of the LEI index

• Average workweek in manufacturing


• Initial weekly claims for unemployment insurance
• New orders for consumer goods and materials
• New orders, nondefense capital goods
• ISM new orders index
• New building permits issued
• Index of stock prices
• Lending credit index
• Yield spread (10-year minus 3-month) on Treasuries
• Index of consumer expectations
Index of leading economic indicators, 1970–2012
Time horizons in macroeconomics

• Long run
Prices are flexible, responding to changes in supply or
demand.
• Short run
Many prices are “sticky” at a predetermined level.

The economy behaves much


differently when prices are sticky.
Recap of classical macro theory (Chapters 3-9)

• Output is determined by the supply side:


• supplies of capital, labor
• technology
• Changes in demand for goods and services (C, I, G) only
affect prices, not quantities.
• Assumes complete price flexibility.
• Applies to the long run.
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
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 in the long run
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.
The quantity equation as aggregate demand

• From Chapter 4, recall the quantity equation:


MV =PY
• For given values of M and V, this equation implies an
inverse relationship between P and Y . . .
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 and
services.
Shifting the AD curve
Aggregate supply in the long run

• Recall from Chapter 3: In the long run, output is


determined by factor supplies and technology

Y = F (K , L )

Y is the full-employment or natural level of output, at


which the economy’s resources are fully employed.

“Full employment” means that unemployment equals its


natural rate (not zero).
The long-run aggregate supply curve
Long-run effects of an increase in M
Aggregate supply in the short run

• Many prices are sticky in the short run.


• For now (and through Chapter 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.
The short-run aggregate supply curve

The SRAS
curve is
horizontal:
The price level
is fixed at a
predetermined
level, and firms
sell as much
as buyers
demand.
Short-run effects of an increase in M
From the short run to the long run

Over time, prices gradually become “unstuck.” When they


do, will they rise or fall?

The adjustment of prices is what moves the


economy to its long-run equilibrium.
The short- and long-run effects of ΔM > 0
How shocking!

• shocks: exogenous changes in aggregate supply or


demand
• Shocks temporarily push the economy away from full
employment.
• example: exogenous decrease in velocity
If the money supply is held constant, a decrease in V
means people will be using their money in fewer
transactions, causing a decrease in demand for goods
and services.
The effects of a negative demand shock

AD shifts left,
depressing output
and employment
in the short run
(B).
Over time, prices
fall, and the
economy moves
down its demand
curve toward full
employment (C).
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.
CASE STUDY: The 1970s oil shocks, part 1

• Early 1970s: OPEC coordinated 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.
CASE STUDY: The 1970s oil shocks, part 2

The oil price shock


shifts up SRAS,
causing output and
employment to fall
(B).
In the absence of
further price
shocks, prices
will fall over time,
and economy
moves back
toward full
employment (A).
CASE STUDY: The 1970s oil shocks, part 3

Predicted effects
of the oil shock:
inflation #
 output $
 unemployment
#
…and then a
gradual recovery
CASE STUDY: The 1970s oil shocks, part 4

Late 1970s: As
the economy
was recovering,
oil prices shot
up again,
causing another
huge supply
shock!
CASE STUDY: The 1980s oil shocks

1980s: A
favorable supply
shock—a
significant fall in
oil prices.
As the model
predicts, inflation
and
unemployment
fell.
Stabilization policy

stabilization policy: policy actions aimed at reducing the


severity of short-run economic fluctuations.
example: using monetary policy to combat the effects of
adverse supply shocks
Stabilizing output with monetary policy, part 1

The adverse
supply shock
moves the
economy to
point B.
Stabilizing output with monetary policy, part 2

But the Fed


accommodates
the shock by
raising aggregate
demand (C).
results:
P is permanently
higher, but Y
remains at its
full-employment
level.
CHAPTER SUMMARY, PART 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.
• Aggregate demand and supply: a framework to
analyze economic fluctuations

3 The
CHAPTER 10
1 National
Introduction
Science
Income
of Macroeconomics
to Economic Fluctuations
CHAPTER SUMMARY, PART 2
• The aggregate demand curve slopes downward.
• The long-run aggregate supply curve is vertical
because output depends on technology and factor
supplies but not prices.
• The short-run aggregate supply curve is horizontal
because prices are sticky at predetermined levels.

3 The
CHAPTER 10
1 National
Introduction
Science
Income
of Macroeconomics
to Economic Fluctuations
CHAPTER SUMMARY, PART 3
• Shocks to aggregate demand and supply cause
fluctuations in GDP and employment in the short
run.
• The Fed can attempt to stabilize the economy with
monetary policy.

3 The
CHAPTER 10
1 National
Introduction
Science
Income
of Macroeconomics
to Economic Fluctuations

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