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CH33 AGGREGATE DEMAND AND AGGREGATE SUPPLY I. Economic activity fluctuates from year to year. A. Definition of  recession : a period of declining real incomes and rising unemployment . B. Definition of  depression : a severe recession . II. Three Key Facts about Economic Fluctuations A. Fact 1: Economic Fluctuations Are Irregular and Unpredictable 1. Fluctuations in the economy are often called the business cycle. 2. Economic fluctuations correspond to changes in business conditions. 3. These fluctuations are not at all regular and are almost impossible to predict. 4. Panel (a) of Figure 1 shows real GDP since 1965. The shaded areas represent recessions. B. Fact 2: Most Macroeconomic Quantities Fluctuate Together 1. Real GDP is the variable that is most often used to examine short-run changes in the  economy. 2. However, most macroeconomic variables that measure some type of income, spending, or  production fluctuate closely together. 3. Panel (b) of Figure 1 shows how investment spending changes over the business cycle. Note  that investment spending falls during recessions just as real GDP does. C. Fact 3: As Output Falls, Unemployment Rises 1. Changes in the economy’s output level will have an effect on the economy’s utilization of its  labor force. 2. When firms choose to produce a smaller amount of goods and services, they lay off workers,  which increases the unemployment rate. 73
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74 Chapter 33/Aggregate Demand and Aggregate Supply 3. Panel (c) of Figure 1 shows how the unemployment rate changes over the business cycle.  Note that during recessions, unemployment generally rises. Note also that the unemployment  rate never approaches zero but instead fluctuates around its natural rate of about 5% or 6%. D. In The News: Offbeat Indicators 1. When the economy goes into a recession, many economic variables are affected. 2. This is an article from  USA Today  discussing how the volume of trash generated by  consumers is related to the health of the economy. III. Explaining Short-Run Economic Fluctuations A. The Assumptions of Classical Economics 1. The classical dichotomy is the separation of variables into real variables and nominal  variables. 2. According to classical theory, changes in the money supply only affect nominal variables. B. The Reality of Short-Run Fluctuations 1. Most economists believe that the classical theory describes the world in the long run but not  in the short run. 2.
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This note was uploaded on 02/24/2012 for the course ECON 254 taught by Professor Love during the Spring '12 term at Florida State College.

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