ch9b - Recap of classical macro theory(Chaps 3-8 Output is...

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slide 0 CHAPTER 9 Introduction to Economic Fluctuations Recap of classical macro theory (Chaps. 3-8) Output is determined by the supply side : supplies of capital, labor technology. Changes in demand for goods & services ( C , I , G ) only affect prices, not quantities. Assumes complete price flexibility. Applies to the long run.
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slide 1 CHAPTER 9 Introduction to Economic Fluctuations Time horizons in macroeconomics Long run: Prices are flexible, respond to changes in supply or demand. Short run: Many prices are “sticky” at some predetermined level. The economy behaves much differently when prices are sticky.
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slide 4 CHAPTER 9 Introduction to Economic Fluctuations When prices are sticky… It is no longer true that the economy can always produce at its capacity and all produced goods and services are eventually sold. How much output can be produced and sold depends on demand.
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slide 5 CHAPTER 9 Introduction to Economic Fluctuations The model of aggregate demand and supply The paradigm most mainstream economists and policymakers use to think about economic fluctuations and policies to stabilize the economy shows how the price level and aggregate output are determined shows how the economy’s behavior is different in the short run and long run
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slide 6 The model of aggregate demand and supply General idea: business cycles arise because unexpected fluctuations in aggregate demand and supply lead to fluctuations in equilibrium price level and GDPs. What we observe: a series of these equilibrium prices and GDPs. CHAPTER 9 Introduction to Economic Fluctuations
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slide 7 CHAPTER 9 Introduction to Economic Fluctuations Aggregate demand The aggregate demand curve shows the relationship between the price level and the quantity of output demanded. It shows planned purchases at various price levels. It is downward-sloping.
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slide 8 CHAPTER 9 Introduction to Economic Fluctuations Aggregate demand The wrong way to think about aggregate demand (AD): the AD curve is downward sloping because the higher the price, the less goods consumers can afford to buy. Therefore they will demand less. This logic (from micro) is true when you consider a single good, say, the market for pizzas. The underlined assumption is income and all other prices do not change.
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slide 9 Aggregate demand Example If the price of pizza increases, given the same level of income, and suppose the prices of other goods do not change, people will demand less pizzas. Key: it is the relative price that matters. With a higher price, pizza becomes more expensive relative to other goods. Hence consumers buy more of other goods and less pizzas. Key: nominal income is assumed fixed. When the
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ch9b - Recap of classical macro theory(Chaps 3-8 Output is...

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