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WEEK 10

TERMINOLOGY

RECESSION = PERIOD OF DECLINE IN THE ECONOMY

Rising unemployment

Declining income

BUSINESS CYCLE

Short time fluctuation in the GDP is referred to as ‘business cycle’

DEPRESSION; A SEVERE RECESSION

TWO METHODS USED TO ANALYSE ECONOMIC FLUCTUATION

1. GDP Deflator

2. CPI

NOMINAL VARIABLES

Measured in terms of dollars

EG, Quantity of money

Inflation rate

REAL VARIABLES

Measured relative to priced or quantities

Eg, Quantity of goods and services produced, Output ,Interest rates ,Unemployment

>> Separation of these two is referred to as Classical Dichotomy

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AGGREGATE DEMAND curve

Total amount of goods and services demanded in the economy at a given price and time

(Basically this means the demand for Gross Domestic Product DGP)

Y = C + I + G + NX

C: Consumption - private spending by consumers I: Investment - includes equipment, inventory, and new homes G: Government spending - does not include transfer payments X: Exports - goods or services that an entity chooses to produce for another entity M: Imports - goods and services from another

REASONS FOR THE AGGREGATE DEMAND CURVE TO SLOPE DOWNWARDS

1. The inflation rate and consumption (The wealth effect)

2. Inflation rate and investment (Interest rate effect)

3. Inflation rate and net exports (Exchange rate effect)

INTEREST RATE EFFECT

High inflation high interest rates decreases the output demanded

EXCHANGE RATE EFFECT

High inflation High interest rates Real value of dollar increase Net exports fall

Decrease in output demanded

THE INFLATION RATE AND CONSUMPTION (THE WEALTH EFFECT)

Decrease of inflation rate Consumers feel wealthy Spend more increase the

demand on goods and services

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WHAT CAUSES A SHIFT IN AGGREGATE DEMAND CURVE

Consumption

Investment

Government purchases

Net exports

WHAT CAUSES THE SHIF OF AGGREGATE DEMAND CURVE IN THE ONG RUN

Labour

Capital

Natural resources

Technological knowledge

AGREGATE SUPPLY

Volume of goods and services produced within an economy at a given price level

(this shows the ability of an economy to deliver goods and service to meet the demand )

AHORT RUN AGGREGATE SUPPLY

Planned output when all input factors are constant

LONG RUN AGGREGAT ESUPPLY

Planned output when both prices and average wage rates can change

** In the long run Long run aggregate supply is vertical

** In the short run short run aggregate supply is upward sloping

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WHAT CAUSES A SHIFT IN AGGREGATE SUPPLY CURVE (SHORT RUN)

1. The misperceptions theory 2. The sticky wage theory 3. The sticky price theory

THE CLAISSICAL MISPERCEPTION THEORY

Suppliers being misled by changes in the inflation rate.

THE STICKY WAG THEORY

Wages, not being change immediately along with the changes in inflation.

STICKY PRICE THEORY

Prices, not being changed immediately along with changes in inflation.

KEYNESIAN SICKY PRICE THEORY

Short run aggregate supply curve slope upwards because prices of some products adjusts slowly to the

economic conditions.

WHAT CAUSES A SHIFT IN SUPPLY CURVE IN THE (LOG RUN)

Labour

Human capital

Physical capital

Natural resources

Technological knowledge

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AGGREGATE SUPPLY CURVE SHORT RUN AND LONG RUN

Short run

Long run

LONG RUN EQUILIBRIUM

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SHIFT IN AGGREGATE DEMAND

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CAUSES FOR ECONOMIC FLUCTUARIONS

Long and short run equilibrium

Shifts in aggregate demand

Shifts in aggregate supply

RASONS WHY AGGREGATE SUPPLY CURVE IS AT A UPWARD SLOPE

1. New classical misperception theory

2. Keynesian sticky-wage theory

3. New Keynesian sticky-price theory

A CONTRACTION IN AGGREGATE DEMAND

Y = Ynatural + a(P - Pexpected). In this equation, Y is output, Ynatural is the natural rate of output that exists when all productive factors are used at their normal rates, ais a constant greater than zero, P is the price level, and Pexpected is the expected price level. This equation holds only in the short run because in the long run the aggregate supply curve is a vertical line, as output is dictated by the factors of production alone.