ECO CH 20 - Recession-period of falling incomes and rising...

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Recession-period of falling incomes and rising unemployment is called a recession Depression-a severe recession Although there remains some debate among economists about how to analyze short-run fluctuations, most economists use the model of aggregate demand and aggregate supply. Short-term fluctuation Facts: Fact 1: Economic Fluctuations Are Irregular and Unpredictable Fact 2: Most Macroeconomic Quantities Fluctuate Together Fact 3: As Output Falls, Unemployment Rises Most economists believe that classical theory describes the world in the long run but not in the short run. To understand how the economy works in the short run, we need a new model. This new model can be built using many of the tools we developed in previous chapters, but it must abandon the classical dichotomy and the neutral- ity of money. We can no longer separate our analysis of real variables such as output and employment from our analysis of nominal variable such as money and the price level. Our new model focuses on how real and nominal variables interact. We analyze fluctuations in the economy as a whole with the model of aggregate demand and aggregate supply - Horizontal axis is the overall quantity of goods and services produced in the economy - Aggregate-demand curve shows quantity of goods and services that households, firms, the government, and customers abroad want to buy at each price level. - Aggregate-supply curve shows the quantity of goods and services that firms produce and sell at each price level. According to this model, the price level and the quantity of output adjust to bring aggregate demand and aggregate supply into balance. The aggregate-demand curve tells us the quantity of all goods and services demanded in the economy at any given price level.
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To understand the downward slope of the aggregate-demand curve, therefore, we must examine how the price level affects the quantity of goods and services demanded for consumption, investment, and net exports. : Why the aggregate demand curve slopes downward: The Price Level and Consumption: The Wealth Effect -A decrease in price level raises the real value of money and makes consumers wealthier, which in turn encourages them to spend more. - An increase in the price level reduces the real value of money, in turn reducing wealth,
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ECO CH 20 - Recession-period of falling incomes and rising...

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