Macroeconomics Chapter 12: Short-Run Fluctuations

Leftward shifts in labor demand during recession

- a fall in output prices - a decrease in output demanded - a decrease in labor productivity - a rise in input prices

Variables that move positively with real GDP

- real consumption - real investment - employment

Variables that move negatively with real GDP

- unemployment

What caused the great recession?

1. A fall in housing prices which caused a collapse in new construction. 2. A sharp drop in consumption 3. Spiraling mortgage defaults that caused many bank failures, leading the entire financial system to freeze up.

Factors contributing to the Great Recession

1. Collapsing housing bubble 2. Fall in household wealth 3. Financial Crisis

Economic shock in the short run

1. Initial shock shifts labor demand curve to the left 2. Downward wage rigidity leads to further reductions 3. Multipliers cause the labor demanded curt to shift leftward even more

Economic recovery in the medium run

1. Market forces from (a) inventory rebuilding, (b) technological advances and (c) financial intermediation shift the labor demand curve to the right for partial recovery. 2. Expansionary monetary policy will lower interest rates and raise inflation. Lower interest rates will raise spending which shifts the labor demand curve to the right. Higher inflation will lower real wages which shifts the labor supply curve to the left.

Theories for sources of Economic Fluctuation

1. Real business cycle theory 2. Keynesian theory 3. Financial & Monetary theory

Multipliers

Can amplify the effects of any economic shock regardless of its source. By lowering household income, multipliers will shift labor demand curve further to the left. As a result, wages and employment will decrease further, to the trough of the business cycle.

Real business cycle theory

Emphasizes changes in productivity and technology. Technological advances and other productivity enhancing innovations cause expansions. Increase in input prices cause recessions.

Keynesian Theory

Focuses on changes in expectations of the future. Believes animal spirits lead to recessions and expansions. During a recession, the initial decrease in spending is further amplified by further decreases in spending due to multipliers.

Financial and Monetary Theory

Looks at changes in prices and interest rates. - A decrease in money supply will cause the price level to fall which reduces employment because of downward wage rigidity. - A decrease in money supply will also cause an increase in real interest rates which will reduce investment spending by firms.

Describe economic growth

Not random, but persistent. When the economy is contracting it will most likely continue to contract the following quarter

Features of Economic Fluctuation

Occur because of technology shocks, changing sentiments, and monetary/financial factors . Shocks are amplified by downward wage rigidity and multipliers 1. Co-movement 2. Limited predictability 3. Persistence

Economic Booms

Periods of GDP expansion associated with increasing employment and declining unemployment

Draw a labor schedule to show the transitions from pre recession to full recovery.

See chapter 12 page 12

Business Cycles

Short run changes in GDP growth. Can be examined by comparing the path of real GDP to a trend line.

Recession

Two consecutive quarters with decreasing GDP levels