ECON 101 Lecture Notes - Lecture 10: Real Business-Cycle Theory, Fiscal Policy, Stagflation
1 May 2018
School
Department
Course
Professor
Economics 101
Lori Leachman
Part 10 • Lecture
• Relationship between AS & AD and the Business Cycle
o AD shifts along AS
▪ Expansion - increasing AD
▪ Peak - high AD in Classical range (fully employment)
▪ Recession - decreasing AD
▪ Trough - low AD in Keynesian range (idle resources & inefficiency)
• Demand pull inflation (good inflation) - shift in AD outwards (increase AD)
o Increases income level and price level
• Cost push inflation (bad inflation)- shift in AS inwards (decrease AS) -
o Decreases income level and increases price level
o Stagflation: inflation while economy is stagnation/sluggish (low growth, low income)
• **Real Business Cycle Theory (Classical) vs Keynesian Theory
o Keynesian - changes in business cycle are due to changes in AD
▪ Government should intervene & manage economy
▪ Demand oriented, uses Fiscal policy
• Expansions due to increasing AD (prices rise)*; contractions due to
decreasing AD (prices fall)*
▪ Assumptions:
• Wages & prices are not flexible (especially downward)
• Savers & investors differ (interest rate flexibility does not guarantee market
clearing)
• Downward spirals in economic activity can develop due to poor economic
expectations (leading to liquidity trap)
o RBC/Classical - changes in business cycle are due to changes in
▪ Government should not intervene; market clears on its own
▪ Supply oriented, uses Monetary policy (only imposes conditions)
• Expansions due to increasing AS (prices fall)*; contractions due to
decreasing AS (prices rise)*
▪ Assumptions:
• Wages, prices, interest rates are flexible
o Anyone who wants job has one; never unemployment above natural
rate (only voluntary unemployment) - job market clears
o prices will rise & fall on its own to accommodate excess
supply/demand - goods market clears
o All money saved returns to economy eventually - asset market clears
• Say’s Law (supply creates its own demand)
find more resources at oneclass.com
find more resources at oneclass.com
