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Section18 - UNIVERSITY OF CALIFORNIA BERKELEY Department of...

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UNIVERSITY OF CALIFORNIA, BERKELEY Dorian Carloni Department of Economics ECON 100B, Fall 2011 SECTION 18: The Aggregate Demand and Supply Model, Part 2 ° Business cycle °uctuations are caused by the combination of: { Positive and negative aggregate demand and { Positive and negative aggregate supply shocks { hitting the economy both simultaneously and sequentially. 18.1. Aggregate Demand Shocks ° Positive demand shocks: 1. Immediately shift the AD curve to the right, 2. Initially leading to increases in economic output and to increases in in°ation, and 3. Ultimately resulting in: (a) No change in economic output, but (b) Permanently higher in°ation. Examples : increase in consumer con±dence, increase in government expenditure, increase in expected future wages, increase in foreign preference for domestic goods, expansionary monetary policy ( r goes down). ° Negative demand shocks: 1. Immediately shift the AD curve to the left, 2. Initially leading to decreases in economic output and to decreases in in°ation, and 3. Ultimately resulting in: (a) No change in economic output, but (b) Permanently lower in°ation. Examples : businesses become more pessimistic about the economy, decrease in consumer wealth, in- crease in domestic preference for foreign goods, contractionary monetary policy ( r goes up). 18.2. Aggregate Supply Shocks 18.2.1 Temporary Aggregate Supply Shocks ° Temporary negative (sign of ° t is positive) supply shocks: 1. Immediately shift the SRAS curve to the left, 2. Initially leading to declines in economic output and to increases in in°ation (i.e., stag°ation), but 3. Ultimately, resulting in no change in either: (a) Economic output or (b) In°ation. Examples : disruption in oil supplies (so oil price goes up), rise in import prices when a currency declines in value, cost-push shock from workers pushing for higher wages that outpace productivity costs, increase in world food prices. 1
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18.2.2 Permanent Aggregate Supply Shocks ° Permanent positive supply shocks: 1. Immediately shift the LRAS curve to the right and increase potential output, 2. Immediately shift the SRAS curve to the right and increase actual output,
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