Explaining Fluctuations Notes

Explaining Fluctuations Notes - Chapter 10 We measure level...

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Chapter 10 - We measure level of economic activity by GDP - Doesn’t grow smoothly over time - Substantial fluctuations in actual output as opposed to potential output Can the Classical Model Explain Economic Fluctuations? - NO - In theory, a recession could be caused by declining labor demand - Hypothetically, what might cause a drop in labor demand in classical model? - Insufficient aggregate demand? - Not possible in classical model - Sudden drop in productivity? - Unlikely - Implies that production techniques are “forgotten” - Or that labor force on average supplies less effort Decreasing Labor Supply? - Hypothetically what might cause a decrease in labor supply in classical model, accounting for a reduction in employment? - Sudden change in preferences for labor vs. Leisure? - Not likely - Average preferences over individuals in population likely to be relatively stable - Sudden drop in population or labor force participation?
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Unformatted text preview: - Also not likely - Demographic trends change very gradually Conclusion - Classical model does not provide satisfactory explanation for economic fluctuations Possible Cause of Economic Fluctuations - Spontaneous mismatches in spending and output because of lack of coordination across economic agents. Spontaneous Reduction in Output - A spontaneous reduction in output causes: - Reduction in income - Reduction in spending - Potentially, a further reduction in output - A spontaneous increase in output causes: - Increase in output - Increase in income - Increase in spending Spontaneous Changes in Spending and Output - How is the classical model inadequate? In contrast to classical model, real world characterized by: A Better Theory of Economic Fluctuations -unpredictable shocks hit economy and propagate through income, spending, and output. - Key question in macro: How can policy offset (at least part of) the effects of these shocks?...
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