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Econ+102+lecture+13%2C+2-21-12+-+SR+fluctuations copy

Econ+102+lecture+13%2C+2-21-12+-+SR+fluctuations copy -...

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Lecture 13: The theory of  short run fluctuations Econ 102, Winter 2012 2/21/2012 1 Required reading : Ch. 12: pp. 329 – 342 Ch 13 apdx: p. 379 Ch. 17: 472 - 476
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Outline 1. The economy in the LR 2. Macro shocks and output gaps 3. The self-correcting mechanism of unregulated markets 4. Towards a theory of government intervention 2/21/2012 2
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The economy in the long run 2/21/2012 3 We’ve developed two of the essential components of our SR model, AD and SRAS Together, they determine the state of the economy at every instant in time But why is AD-SRAS a model of SR “fluctuations”? Need to develop the model a bit further. Define the long run aggregate supply curve (LRAS) as the relationship between aggregate prices and output when prices can fully adjust to any change in the economy
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The economy in the long run What do these “fully adjusting prices” imply here? Perfectly flexible wages – there is “enough time” to negotiate changes in every wage contract (or to hire new workers) Factor markets clear. All available resources are used at their natural rate of utilization Just as in the growth model. The LRAS describes the full employment level of production Also called the level of potential output Also implies perfectly flexible aggregate prices . LRAS is the opposite of the sticky price SRAS: when shocks occur, rGDP changes not-at-all, P fully 2/21/2012 4
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The economy in the long run Agg P rGDP 5 2/21/2012
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The economy in the long run P rGDP 6
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Shocks and gaps 2/21/2012 7 This situation where SR=LR output is a special case If always true, we wouldn’t have fluctuations If always true, we wouldn’t need a SR model To have a theory of fluctuations, we must have the SR equilibrium occurring off the LRAS This will create a difference between potential output and actual output (from AD=SRAS) Such differences are called output gaps . x100 output potential output potential output actual gap output - =
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Shocks and gaps 2/21/2012 8 Note that to calculate OG, we need to know output (rGDP) and not the growth rate (g) Output gaps can be positive or negative Interpretation: “how much higher or lower is actual output relative to potential (full employment)?” E.g., OG = 2  “Actual output is 2% higher than potential” OG = -4  “Actual output is 4% lower than potential” So, how do these output gaps arise?
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