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Chapter #14 ECN.docx

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ECN 204
Christopher Gore

Chapter 14Over the long run real GDP grows about 2 per year on averageIn the short run GDP fluctuates around its trendRecessionsperiods of falling real incomes and rising unemploymentDepressionssevere recessions very rareShortrun economic fluctuations are often called business cycles Fluctuations correspond to changes in business conditionsWhen GDP grows rapidly the business is goodFirms find that customers are plentiful and that profits are growingWhen GDP falls during recessionBusinesses have troubleFirms experience declining sales and dwindling profitsThree Key Facts about Economic Fluctuations 1 Economic fluctuations are irregular and unpredictable 2 Most macroeconomic quantities fluctuate togetherwhen GDP falls so does the income and revenuesmacroeconomic variables fluctuate togetherbut they fluctuate by different amountsSpending is lessLess investments made on plants factories business 3 As output falls unemployment risesCorrelated with utilization of its labour forceWhen firms choose to produce a smaller quantity of goods and services they lay off workers expanding the pool of unemploymentExplaining these fluctuations is difficult and the theory of economic fluctuations is controversialMost economists use the model of aggregate demand and aggregate supply to study fluctuations This model differs from the classical economic theories economists use to explain the long runAs output falls unemployment rises hence GDP falls Classical EconomicsA RecapMost economists believe classical theory describes the world in the long run but not the short run Money is a veilnominal variables may be the first things we see when we observe an economy because economic variables are often expressed in units of moneyBut whats important are the real variables and the economic forces that determine them In the short run changes in nominal variables like the money supply or Pcan affect real variables like Y or the urateTo study the short run we use a new model The Basic Model of Aggregate Demand and Aggregate Supply Economists use the model of aggregate demand and aggregate supply to explain shortrun fluctuations in economic activity around its longrun trendThe aggregatedemand curve shows the quantity of goods and services that households firms and the government want to buy at each price levelThe aggregatesupply curve shows the quantity of goods and services that firms choose to produce and sell at each price level The Price Level and Consumption The Wealth EffectP and CSuppose P risesThe dollars people hold buy fewer gs so real wealth is lower People feel poorer ResultCfallsA decrease in the price level makes consumers wealthier which in turn encourages them to spend moreThe increase in consumer spending means a larger quantity of gs demandedConversely an increase in the price level reduces the real value of money in turn reducing wealth consumer spending and the quantity of goods and services demanded
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