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ECON 305

Econ 9 10/18/13  Short-run fluctuations  GDP and its components  Recession is a decline in real GDP • Investment and consumption also decline (investment at a higher rate)  Unemployment and Okun’s law  Unemployment rises in recession  Okun’s law: the negative relationship between unemployment and real GDP.  % change in real GDP = 3% - 2 X (change in unemployment rate) • U rate rise from 5 to 7, (7-5) plugged in  Leading economic indicators  Leading indicators: variables that tend to fluctuate in advance of the overall economy • Avg workweek of production workers in manufacturing ♦ Long work week means high demand for products (hire new soon) • Avg initial weekly claims for unemployment insurance ♦ Means people will soon be unemployed • New orders for consumer goods and materials, adjusted for inflation ♦ Increase production and employment • New orders for nondefense capital goods • Index of supplier deliveries ♦ Slower deliveries mean more is being ordered so production is going up • New building permits issued ♦ Increase investment and economic activity • Index of stock prices ♦ Increase in stock prices mean expect to be profitable • Money supply (m2) adjusted for inflation ♦ More money means increased spending • Interest rate spread ♦ Large spread means interest rate rises and increase economic activity • Index of consumer expectations ♦ Optimism means increased consumer demand  Time horizons  In the long run a reduction in the money supply means a decrease in prices but output and employment stay the same  Short run: a reduction in the money supply does not cause an immediate reaction of prices, and output and employment fluctuate  Aggregate supply and aggregate demand  In short run where prices are sticky, demand is what influences output • Demand is influenced by consumers confidence in economic prospects, firms perceptions about profitability of new investments, and monetary and fiscal policy  Aggregate demand: the relationship between the quantity of output demanded and the aggregate price level.  The quantity of goods and services people want to buy at any given level of prices  (M/P) = (M/P)^d = kY  Supply equals demand,
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