Case Studies Ch 3 b

Case Studies Ch 3 b - LECTURE SUPPLEMENT 3-1 How Long Is...

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LECTURE SUPPLEMENT 3-1 How Long Is the Long Run? Part One The models of the economy presented in Parts II and III of the book are models of the long run, whereas the models in Part IV are short-run models. So how long is the long run? The answer is that it depends both on the world and on the model. The key feature of the classical model (Chapter 3) that makes it a long-run model is that prices are flexible. In other words, prices are assumed to adjust in that model to ensure equality of supply and demand in all markets. In the short-run models of Part IV, by contrast, it is often assumed that prices are instead sticky, and so do not adjust to equilibrate all markets. The most basic answer to the question is then that the long run is however long it takes for prices to be free to adjust in all markets in the economy. Whereas prices can move instantaneously in some markets, they may be fixed for months (or even years, in the case of labor contracts) in other markets. As a rule of thumb, most economists would probably think about price stickiness as being relevant over a time horizon of a few months up to a couple of years, but not over large numbers of years. 57
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62 LECTURE SUPPLEMENT 3-4 Economists’ Terminology Like all sciences, economics has a well-developed terminology (jargon). Such a language is important because it allows economists to talk precisely about the economy and to avoid ambiguity. But this terminology presents pitfalls for the uninitiated, since economists have an annoying habit of taking terms that are used in everyday speech and giving them a precise meaning that may not exactly match their everyday meanings. We consider some examples here. Saving and Investment In everyday speech, people use the term “investment” to refer to any purchase of an asset, such as stocks and bonds, works of art, old or new housing, and the like. Macroeconomists usually use the term much more precisely to refer only to certain purchases of newly produced final goods and services. If a firm buys a new machine, or if an individual buys a new house, then that is investment as far as the macroeconomist is concerned. If an individual buys IBM shares, or a Renoir painting, that is not investment in the macro- economic sense; it is rather an individual act of saving. Such purchases merely reallocate
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Case Studies Ch 3 b - LECTURE SUPPLEMENT 3-1 How Long Is...

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