To sum up: What is an Equilibrium?SHORT RUN EQUILIBRIUM:AD = SRAS and IS = LM The Labor Market need not be in equilibriumWe need not be at the potential level of GDP Y*If Y<Y* we are in a recession, if Y>Y* in a boomLONG RUN EQUILIBRIUM:AD = SRAS = Y* and IS = LM = Y* and Nd= Ns= N*By definition, the labor market will clearBy definition, we will move to Y*.2
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Real Business Cycle (RBC)Wh tlld ithbil ?•What really drives the business cycle?•Kydland and Prescott developed the RBC theory that argues that real shocks to the economy are the primary cause of business cyclereal shocks to the economy are the primary cause of business cycle.•Real shocks are shocks that affect the production function, the size of the labor force the spending and savings decisionsNominal shocksthe labor force, the spending and savings decisions,…Nominal shocks are shocks to money supply or demand•In particular the RBC theory refer toproductivity shocksIn particular the RBC theory refer to •The RBC theory is consistent with our IS-LM and AD-AS models. A negative productivity shock (A decreases) has two effects:1)reduces MPN and hence the demand for labor and N*2)Decreases Y* directly4•Both effects make Y* to decrease (LRAS) and hence LM has to adjust!