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THEECONOMYINTHESHORTRUN

Short-Run

Fluctua-tions

Aggregate

Spending

MonetaryPolicy

Inflation

Policy

Analysis


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LEARNINGOBJECTIVES

1. Identify the four phases of the business cycle

2. Symptoms of Business Cycles

3. How we tell whether a particular recession or

expansion is big or small??

4. Causes of short-term fluctuations


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FLUCTUATIONSINUS REALGDP, 1920-2007


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FOUR PHASES OF BUSINESS CYCLES

These fluctuations in GDP are known as

business cycles.

Recession(or contraction) is a period in which the

economy is growing at a rate below normal

Depressionan extremely severe or protracted

recession is called a depression.

A peakis the beginning of a recession

High point of the business cycle

A troughis the end of a recession

Low point of the business cycle


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FOUR PHASES OF BUSINESS CYCLES

The opposite of a recession is an expansion.

A particular strong expansion is called a boom.


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SHORT-TERMECONOMICFLUCTUATIONS

Economists have studied business cycles for at

least a century

Recessions and expansions are irregular in their length

and severity

Contractions and expansions affect the entire economy

May have global impact

Great Depression of the 1930s was worldwide

US recessions of 19731975 and 19811982

East Asian slowdown in the late 1990s


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REALGDP GROWTH, 19992004

Canada

Germany

United Kingdom

Japan


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SYMPTOMSOFBUSINESSCYCLES

Cyclical unemployment rises sharply during

recessions

Real wages grow more slowly for those employed

Promotions and bonuses are often deferred

New labor market entrants have difficulty finding work

Production of durable goods is more volatile than

services and non-durable goods

Cars, houses, capital equipment less stable


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SYMPTOMSOFBUSINESSCYCLES

Inflation generally decreases during a recession

Decreases at other times as well


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OUTPUTGAPS& CYCLICALUNEMPLOYMENT

How we tell whether a particular recession or

expansion is big or small??

Answer: the deviations of output and

unemployment

Potential output, Y* , is the maximum sustainable

amount of real GDP that an economy can produce.

Actual output does not always equal potential

output.


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OUTPUTGAPS

Output gapis the difference between potential

output and actual output at a point in time

Output gap = [(YY*)/Y*] x 100%

Recessionary gapis a negative output gap; Y* > Y

Expansionary gapis a positive output gap; Y* < Y

Policymakers consider stabilization policies when

there are output gaps

Recessionary gaps mean output and employment are

less than their sustainable level

Expansionary gaps lead to inflation to ration output


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NATURALRATEOFUNEMPLOYMENT

Recessionary gaps have high unemployment rates

Expansionary gaps have low unemployment rates

The natural rate of unemployment, u*, is the sum

of frictional and structural unemployment

Unemployment rate when cyclical unemployment is 0

Occurs when Y = Y*

Cyclical unemployment is the difference between

total unemployment, u, and u*

Recessionary gaps have u > u*

Expansionary gaps have u < u*


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CAUSES OF SHORT-TERM

FLUCTUATIONS


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CAUSESOFSHORT-TERMFLUCTUATIONS

Output gaps arise for two main reasons

Markets require time to reach equilibrium price and

quantity

Firms change prices infrequently

Quantity produced is not at equilibrium during the adjustmentperiod

Firms produce to meet the demand at current prices


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Output gaps arise for two main reasons

Changes in total spending at preset prices affects output

levels

When spending is low, output will be below potential output

Changes in economy wide spending are the primary causes ofoutput gaps

Policy: adjust government spending to close the output gap

CAUSESOFSHORT-TERMFLUCTUATIONS


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THEECONOMICNATURALIST10.1: DYNAMIC

PRICING

Coca-Cola tested machines that could modify

prices according to demand

Temperature sensors triggered higher prices on hot

days

Machines could raise prices for periods of high demand

Justified as a response to consumer demand

Barriers to flexible pricing

Sophisticated vending machines increase costs

Consumers reacted negatively to change in pricingpractices


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CONCLUSION

Short-Term

Economic

Fluctuations

Business

Cycles

4 Phases of

Business Cycles

Symptoms

CausesPotential

Output

Output

Gaps

Natural Rate of

Unemployment

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