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new_notes_on_business_cycles - Economics 102 UCLA Professor...

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Economics 102 UCLA Professor Lee Ohanian Notes on Business Cycles Economic growth does not proceed at identical rates, year in and year out. Instead, sometimes the economy grows faster than average, and sometimes the economy grows slower than average or even declines. We call periods of rapid growth an expansion , and we call periods of slow growth or economic decline recessions . Expansions are periods of high prosperity: consumption is higher than average, investment is higher than average, the stock market is high, and the number of people working increases. Recessions are periods in which consumption, investment, and the stock market fall, and in which fewer people work, which raises the unemployment rate. Business cycles are important. Your job prospects will be impacted significantly depending on whether the economy is in an expansion or recession. Voters care about business cycles. Almost all presidential elections can be predicted on the basis of how well the economy is doing. Despite the substantial personal and political problems What causes expansions and recessions? We will think about the role of productivity changes. We learned earlier about the role of productivity change in contributing to long-run growth. Now, we will examine the implications of this for short-run changes in the economy. One key reason why economists think productivity is so important is because its short-run changes are highly correlated with changes in output. This is clearly seen in Figure 19-1 in Mankiw. The graph shows that when productivity growth is high, output growth is high, and when productivity growth is low, output growth is low. A Model of Robinson Crusoe
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Think of Robinson Crusoe operating his own economy. That is, he chooses how much time to work, how much to consume, and how much to invest in his capital stock. Also, imagine that he produces output using capital and labor, and that his ability to produce is affected by changes in productivity - which in this case might be changes in weather that either make it easy to produce output, or hard to produce output. The productivity parameter will be a multiplicative shock that we will call z t , and that affects the production function the following way: z t F k t , l t We will think about a single person doing all this because it is the simplest way to understand how productivity changes affect economic decisions. To keep the analysis as simple as possible, imagine that Crusoe makes decisions for 2 periods, period t and period t 1. We assume that Crusoe makes no decisons after period t 1. Crusoe likes consumption, and dislikes working. We incorporate these assumptions into his preferences as : max c t v l t c t 1 v l t 1  Two factors that govern Crusoe’s decisons will be the marginal utility of consumption, and the marginal disutility of working. We make the following assumptions about the marginal disutility of working: We suppose that v(l t
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new_notes_on_business_cycles - Economics 102 UCLA Professor...

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