Econ 114 - Chapter 14 Lecture Notes (Student Copy)(1).doc

Econ 114 - Chapter 14 Lecture Notes (Student Copy)(1).doc -...

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CHAPTER 14: AGGREGATE DEMAND AND AGGREGATE SUPPLY I. Economic activity fluctuates from year to year. A. Definition of recession : a period of declining real incomes and rising unemployment . B. Definition of depression : a severe recession . II. Three Key Facts about Economic Fluctuations A. Fact 1: Economic Fluctuations Are Irregular and Unpredictable 1. Fluctuations in the economy are often called the business cycle. 2. Economic fluctuations correspond to changes in business conditions. 3. These fluctuations are not at all regular and are almost impossible to predict. 4. Panel (a) of Figure 14.1 shows real GDP since 1966. The shaded areas represent times of recession. B. Fact 2: Most Macroeconomic Quantities Fluctuate Together 1. Real GDP is the variable that is most commonly used to monitor short- run changes in the economy. 2. However, most macroeconomic variables that measure some type of income, spending, or production fluctuates closely together. 3. Figure 14.1 shows how investment changes over the business cycle.
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C. Fact 3: As Output Falls, Unemployment Rises 1. Changes in the economy’s output level will have an effect on the economy’s utilization of its labour force. 2. When firms choose to produce a smaller amount of goods and services, they lay off workers which increases the unemployment rate. 3. Figure 14.1 shows how the unemployment rate changes over the business cycle.
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III. Explaining Short-Run Economic Fluctuations A. The Reality of Short-Run Fluctuations 1. Most economists believe that the classical theory describes the world in the long run but not in the short run. 2. Beyond a period of several years, changes in the money supply affect prices and other nominal variables, but do not affect real GDP, unemployment, or other real variables. 3. However, when studying year-to-year fluctuations in the economy, the assumption of monetary neutrality is not appropriate. In the short run, most real and nominal variables are intertwined. C. The Model of Aggregate Demand and Aggregate Supply 1. Definition of model of aggregate demand and aggregate supply : the model that most economists use to explain short-run fluctuations in economic activity around its long-run trend . 2. We can show this model using a graph. a. Definition of aggregate-demand curve : a curve that shows the quantity of goods and services that households, firms, and the government want to buy at each price level . d. Definition of aggregate-supply curve : a curve that shows the quantity of goods and services that firms choose to produce and sell at each price level .
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