Title: Economic Fluctuations I
1Economic Fluctuations I
FIRST STEPS
2What are recessions?What causes them? Why do
they end? A role for government?
3This mornings headlines
4(No Transcript)
5First key idea of the theory of economic
fluctuations
- Recessions and booms are departures of real GDP
from potential GDP
6Second key idea of the theory of economic
fluctuations.
- The departures are due to changes in demand
(aggregate demand). But why?
7What about fluctuations in potential GDP?
- These are usually too smooth to explain
recessions. - Rarely is there a huge decline in labor, capital,
or technology at the time of a recession - Exceptions are important and have huge effects,
but not the typical recession - AIDS epidemic in Africa
- Hurricane Mitch in central America
8Using the Key Ideas
- Aggregate demand can be obtained by adding up
spending C I G X - Example forecast real GDP for 1999
- Y C I G X
- BUT WATCH OUT C depends on Y, because Y is
income too example C 1000 .6Y Y C
I G X - To see the implications of this dependence, put I
and X on the backburner for now
9A consumption function Algebra example C
1000 .6Yor in numerical form
10Or the same consumption function in graphical
form
11Making sure both relationships are satisfied
- Income (which equals spending) depends on
consumption - Or in equation form, Y C I G X
- this is the income-spending identity
- Consumption depends on income
- Or in equation from, C 1000 .6Y
- this is the consumption function
12Economists fool around with the second
relationship (the consumption function) a little
bit
- They add investment (I), government purchases
(G), and net exports (X) to the consumption
function - They get a total sum which shows how C
I G X depends on income - They call this total sum the aggregate
expenditure line
13The aggregate expenditure (AE) line
14Note that the AE line shifts up and down if G or
I or X change (question what is the effect of
the Asian financial crisis on AE in the United
States?)
15Now lets remind ourselves that spending equals
income graphically this gives the 45-degree line
16Put the AE line and the 45 degree line together
to get spending balance
17Sometimes numerical examples help one see
spending balance better
18Finally, lets imagine that the AE line shifts
down, perhaps because of the Asian financial
crisis
19In general, when the AE line shifts, real GDP
falls (d) or rises (e)
20It is hard to imagine the AE line shifting. Can
you show how this works with animated graphics
or just a blackboard?
21These falls or rises take real GDP away from
potential GDP
- They are the first steps toward recession (d) or
boom (e)
22But they are not the final steps
- To see what happens next (and ultimately to see
why the economy recovers from recession), we need
to look at the forces of adjustment in the
economy - These forces are the subject of the next lecture
23END OF LECTURE