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Chapter 7

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Boston College
ECON 1132
Glen Peterson

Chapter 7 – Business Cycle andAggregate Demand Keynesian economics states that changes in aggregate demand can have powerful impacts on the overall levels of output, employment, and prices in the short run Business cycles – economy-wide fluctuations in total national output, income, and employment over a period of 2-10 years marked by widespread expansion or contraction Recession – a recurring period of decline in total output, income, and employment lasting from 6 to 12 months and marked by contractions in many sectors of the economy - Alarge scale recession is called a depression Characteristics of a recession: - Investment falls sharply, with usually housing declining first - Consumers purchase less and businesses slow production, so GDP falls - Employment and business profits fall sharply Exogenous theories – find sources of the business cycle in the fluctuation of factors outside the economic system (wars, revolutions, elections) Internal theories – look for mechanisms in the economic system Hyperinflation – occurs when prices ride at 100% or more per month Four components of aggregate demand: 1. Consumption – mainly determined by disposable income, but also affected by wealth and current price level 2. Investment – purchases of buildings, software, and equipment 3. Government purchases – purchases of defense supplies, school books, wages of judges, etc 4. Net exports – value of exports minus value of imports The level of real spending declines as the overall price level in the economy rises Determinants of AD:
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