Short term fluctuations

3/31/11

Short Run Fluctuations in the Economy

• Shows booms and busts in the economy (historical slide of business cycles since 1929)
• Short Economic Recessions
• The above comes from Aggregate Expenditure identity o Y= C + I+ G + NX o the left side is the aggregate supply while the left is the aggregate demand
• Aggregate Demand Curve- relates the dprice level to aggregate expemdentiure on the economy’s goods (…) o on vertical axis = P a measure of the overall price level o on horizontal axis = total amount of aggregate expenditure or GDP o the higher the price level the lower the aggregate expenditure o Quantity Demanded- point on the demand curve
• Point of aggregate expenditure
• Moving along the curve o Increase in Aggregate Expenditure P ^ and Y goes down o Why is it downward slopping, when Price level changes these effects occurs
• The Wealth Effect- due to the consumption function, wealth decrease when the price level goes up, and hence consumption goes down and hence Y goes down
• Interest Rate Effect- when the price level goes up the real interest rate goes up, there is more incentive to save it costs more to borrow. Together those mean that consumption spending goes down.
• Investment goes down when interest rates go down o Lower Net Present Value
• Discount rate is great than the Rate of Return o It costs more to borrow
• Net Exports goes down: logic chain o r goes up>
• International Trade Effect- when domestic price levels goes up real exchange rate goes up NX goes down, aggregate expenditure effect o Demand-
• Aggregate demand the whole line, not just at one point
• An increase in aggregate demand means a rightward shift of the line
• Same price level but higher aggregates spending
• A decrease in aggregate expenditure means a leftward shift in the demand curve
• Same price level, but lower aggregate expenditure
• What could shift the Aggregate demand curve?

Government Policies
• Monetary policy- policies