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Transcript
macro Roadmap to this Lecture We abandon the view that production is determined by technology and full employment of production factors (i.e., there can be unemployment and capital underutilization) Short-run frictions prevent full factor utilization in the short-run and distort optimal economic outcomes When this happens, what can we do? Introduction to Economic Fluctuations – Monetary Policy – Fiscal Policy The AD/AS model is the basic tool to think about policy ECN 101 – MACROECONOMICS Real GDP Growth in the U.S., 19601960-2004 Time horizons Percent change from four quarters earlier 10 8 Peak Average growth rate = 3.4% 6 Prices are flexible, respond to changes in supply or demand many prices are “sticky” at some predetermined level (or there are other frictions, e.g. information) 2 0 Trough -4 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 ECN 101 – MACROECONOMICS slide 2 In Classical Macroeconomic Theory, Output is determined by the supply side: – supplies of capital, labor – technology The economy behaves much differently when prices are sticky. ECN 101 – MACROECONOMICS slide 3 When prices are sticky …output and employment also depend on demand for goods & services, which is affected by Changes in demand for goods & services (C, I, G ) only affect prices, not quantities. fiscal policy (G and T ) monetary policy (M ) Complete price flexibility is a crucial assumption, so classical theory applies in the long run. ECN 101 – MACROECONOMICS Long run: Short run: 4 -2 slide 1 other factors, like exogenous changes in C or I. slide 4 ECN 101 – MACROECONOMICS slide 5 1 The model of aggregate demand and supply Aggregate demand The aggregate demand curve shows the the paradigm that most mainstream relationship between the price level and the quantity of output demanded. economists & policymakers use to think about economic fluctuations and policies to stabilize the economy For now, we derive the AD/AS model with a simple theory of aggregate demand based on the Quantity Theory of Money. shows how the price level and aggregate output are determined Later we will develop the theory of shows how the economy’s behavior is aggregate demand in more detail. different in the short run and long run ECN 101 – MACROECONOMICS slide 6 The Quantity Equation as Aggregate Demand Recall the quantity equation MV = PY than solely determined by technology and available factors). P causing a decrease in the demand for goods & services. For given values of M and V, QTM implies an inverse relationship between P and Y: slide 7 The downwarddownward-sloping AD curve An increase in the price level causes a fall in real money balances (M/P ), We now assume that Y is flexible (rather AD Y ECN 101 – MACROECONOMICS slide 8 ECN 101 – MACROECONOMICS slide 9 Using Total Differentiation to Make the Same Point Shifting the AD curve Recall M V = P Y (QTM) P The slope of the aggregate demand curve is An increase in the money supply shifts the AD curve to the right. determined by how prices change when income changes by one unit, everything else constant Totally differentiating QTM: M dV + V dM = P dY + Y dP AD2 Notice, dV = dM = 0 AD1 Y ECN 101 – MACROECONOMICS ECN 101 – MACROECONOMICS slide 10 Hence: dP/dY = -P/Y < 0 ECN 101 – MACROECONOMICS slide 11 2 Aggregate Supply in the Long Run In the long run, output is determined by Aggregate Supply in the Long Run Recall from chapter 3: factor supplies and technology In the long run, output is determined by factor supplies and technology Y = F (K , L ) Y = F (K , L ) Y is the full-employment or natural level of output, the level of output at which the economy’s resources are fully employed. on the price level, so the long run aggregate supply (LRAS) curve is vertical: “Full employment” means that unemployment equals its natural rate. ECN 101 – MACROECONOMICS slide 12 The longlong-run aggregate supply curve P Full-employment output does not depend ECN 101 – MACROECONOMICS LongLong-run effects of an increase in M P LRAS The LRAS curve is vertical at the full-employment level of output. slide 13 In the long run, this increases the price level… LRAS P2 An increase in M shifts the AD curve to the right. P1 AD2 AD1 Y Y ECN 101 – MACROECONOMICS slide 14 Aggregate Supply in the Short Run …but leaves output the same. Y Y ECN 101 – MACROECONOMICS slide 15 The short run aggregate supply curve In the real world, many prices are sticky in P the short run. The SRAS curve is horizontal: For now, assume that all prices are stuck at a predetermined level in the short run… The price level is fixed at a predetermined level, and firms sell as much as buyers demand. …and that firms are willing to sell as much at that price level as their customers are willing to buy (why is this a sensible exercise?) Therefore, the short-run aggregate supply P SRAS Y (SRAS) curve is horizontal: ECN 101 – MACROECONOMICS slide 16 ECN 101 – MACROECONOMICS slide 17 3 ShortShort-run effects of an increase in M In the short run when prices are sticky,… Over time, prices gradually become “unstuck.” When they do, will they rise or fall? P …an increase in aggregate demand… In the short-run equilibrium, if SRAS AD2 AD1 P …causes output to rise. Y1 Y Y2 ECN 101 – MACROECONOMICS slide 18 The SR & LR effects of ∆M > 0 A = initial equilibrium P From the short run to the long run then over time, the price level will Y >Y rise Y <Y fall Y =Y remain constant This adjustment of prices is what moves the economy to its longlong-run equilibrium. ECN 101 – MACROECONOMICS slide 19 How shocking!!! shocks: exogenous changes in aggregate LRAS supply or demand Shocks temporarily push the economy away B = new shortrun eq’m after Fed increases M from full-employment. C P2 B P If the money supply is held constant, then a decrease in V means people will be using their Y Y2 Y exogenous decrease in velocity SRAS AD2 AD1 A C = long-run equilibrium An example of a demand shock: ECN 101 – MACROECONOMICS slide 20 The effects of a negative demand shock The shock shifts AD left, causing output and employment to fall in the short run Over time, prices fall and the economy moves down its demand curve toward fullemployment. P P A C P2 ECN 101 – MACROECONOMICS SRAS AD1 AD2 Y2 Y ECN 101 – MACROECONOMICS slide 21 Supply shocks A supply shock alters production costs, affects the prices that firms charge. (also called price shocks) LRAS B money in fewer transactions, causing a decrease in demand for goods and services: Y Examples of adverse supply shocks: Bad weather reduces crop yields, pushing up food prices. Workers unionize, negotiate wage increases. New environmental regulations require firms to reduce emissions. Firms charge higher prices to help cover the costs of compliance. (Favorable supply shocks lower costs and prices.) slide 22 ECN 101 – MACROECONOMICS slide 23 4 CASE STUDY: CASE STUDY: The 1970s oil shocks The 1970s oil shocks Early 1970s: OPEC coordinates a reduction in the The oil price shock shifts SRAS up, causing output and employment to fall. supply of oil. Oil prices rose 11% in 1973 68% in 1974 16% in 1975 In absence of further price shocks, prices will fall over time and economy moves back toward full employment. Such sharp oil price increases are supply shocks because they significantly impact production costs and prices (and each unit of GDP required much more oil to be produced. Now the economy is more service oriented – a massage requires little oil). ECN 101 – MACROECONOMICS slide 24 CASE STUDY: P P2 LRAS B SRAS2 SRAS1 A P1 AD Y2 Y Y ECN 101 – MACROECONOMICS slide 25 CASE STUDY: The 1970s oil shocks The 1970s oil shocks 60% 70% 14% 12% Predicted effects of the oil price shock: • inflation ↑ • output ↓ • unemployment ↑ …and then a gradual recovery. 60% 50% 50% 10% 40% 8% 30% 20% 6% 10% 4% 0% 1973 1974 1975 1976 1977 8% 20% 6% 10% 0% 1977 1978 1979 1980 Change in oil prices (left scale) Inflation rate-CPI (right scale) Unemployment rate (right scale) Unemployment rate (right scale) slide 26 40% 10% 30% 8% 20% 10% 6% 0% -10% 4% -20% -30% 2% -40% 1983 1984 1985 ECN 101 – MACROECONOMICS 4% 1981 slide 27 Stabilization policy The 1980s oil shocks -50% 1982 10% 30% Inflation rate-CPI (right scale) CASE STUDY: As the model would predict, inflation and unemployment fell: 12% 40% Change in oil prices (left scale) ECN 101 – MACROECONOMICS 1980s: A favorable supply shock-a significant fall in oil prices. Late 1970s: As economy was recovering, oil prices shot up again, causing another huge supply shock!!! 1986 definition: policy actions aimed at reducing the severity of short-run economic fluctuations. Example: Using monetary policy to combat the effects of adverse supply shocks: 0% 1987 Change in oil prices (left scale) Inflation rate-CPI (right scale) Unemployment rate (right scale) ECN 101 – MACROECONOMICS slide 28 ECN 101 – MACROECONOMICS slide 29 5 Stabilizing output with monetary policy The adverse supply shock moves the economy to point B. P P2 Stabilizing output with monetary policy LRAS B But the Fed accommodates the shock by raising agg. demand. SRAS2 A P1 SRAS1 AD1 Y2 ECN 101 – MACROECONOMICS Y Y slide 30 results: P is permanently higher, but Y remains at its fullemployment level. P P2 LRAS B C A P1 ECN 101 – MACROECONOMICS SRAS2 AD1 Y2 Y AD2 Y slide 31 6