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Economic Fluctuations I

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Exceptions are important and have huge effects, but not the typical recession ... They are the first steps toward recession (d) or boom (e) But they are not ... – PowerPoint PPT presentation

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Title: Economic Fluctuations I


1
Economic Fluctuations I
FIRST STEPS
2
What are recessions?What causes them? Why do
they end? A role for government?
3
This mornings headlines
4
(No Transcript)
5
First key idea of the theory of economic
fluctuations
  • Recessions and booms are departures of real GDP
    from potential GDP

6
Second key idea of the theory of economic
fluctuations.
  • The departures are due to changes in demand
    (aggregate demand). But why?

7
What 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

8
Using 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

9
A consumption function Algebra example C
1000 .6Yor in numerical form
10
Or the same consumption function in graphical
form
11
Making 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

12
Economists 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

13
The aggregate expenditure (AE) line
14
Note 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?)
15
Now lets remind ourselves that spending equals
income graphically this gives the 45-degree line
16
Put the AE line and the 45 degree line together
to get spending balance
17
Sometimes numerical examples help one see
spending balance better
18
Finally, lets imagine that the AE line shifts
down, perhaps because of the Asian financial
crisis
19
In general, when the AE line shifts, real GDP
falls (d) or rises (e)
20
It is hard to imagine the AE line shifting. Can
you show how this works with animated graphics
or just a blackboard?
21
These falls or rises take real GDP away from
potential GDP
  • They are the first steps toward recession (d) or
    boom (e)

22
But 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

23
END OF LECTURE
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