short-run fluctuations

Learning Objectives:
introduction to aggregate demand
aggregate supply in the short run & long run
difference between short run & long run AS


CONTENT
1. Introduction
2. Aggregate demand (AD)
3. Aggregate supply (AS)
3.1 Short-run AS
3.2 long-run AS
4. Long-run AS & AD
1. Introduction

Three Key Facts about Economic Fluctuations:




Recession: a period of declining real incomes and rising
unemployment
Depression: a severe recession
FACT1: Economic Fluctuations (business cycle) are
Irregular and Unpredictable
Fact 2: Most Macroeconomic
Quantities Fluctuate Together

Most macroeconomic variables (income,
spending, or production) fluctuate closely
together.
Despite fluctuating together, they fluctuate by
different amounts.

FACT 3: As output falls,
Unemployment rises
Smaller production > lay off workers

recession ends > real GDP starts to expand >
unemployment rate gradually declines (never
approaches zero)
2. Aggregate Demand
aggregate demand (AD) is the total demand for
final goods and services in the economy at a
given time and price level.
Aggregate-demand curve shows the quantity of
goods and services that households, firms, the
government, and customers abroad want to buy
at each price level.
The AD curve shows the relationship between
the P level and demanded output Y.

Graph: Aggregate Demand
example
USD 1 vs ice-cream
Discount time
P level (decrease) > raises real value of money
and makes consumers wealthier > more M
supply (lower r)
3. aggregate-supply
Aggregate supply (AS) is defined as the total
amount of goods and services (real output)
produced and supplied by an economy's firms
over a period of time.
aggregate-supply curve shows the quantity of
goods and services that firms produce and sell
at each price level.
3.1 Short-run AS
Short-run AS
wages are sticky in the short run.
Sticky-Price Theory: P > output > production &
employment

E.g: noodle soup in Cambodia
3.2 Long-run aggregate supply
4. Long-run AS & AD

End of session
AD & AD curve
Short-run AS & its curve
Long-run AS & its curve
Long-run AD & AS curves
Appendices
previous analysis was based on two related ideas:
the classical dichotomy and monetary neutrality.
classical dichotomy is the separation of variables
into real variables (those that measure quantities
or relative prices) and nominal variables (those
measured in terms of money).
Most economists believe that classical theory
describes the world in the long run but not in the
short run.
Changes in Ms > different long-run GDP

Why LRAS curve is vertical? Because the price
level does not affect the long-run
determinants of real GDP
costs to adjusting prices, called menu costs
The downward-sloping AD curve
An increase in
the price level
causes a fall in
real money
balances (M/P ),
causing a
decrease in the
demand for
goods & services.
P
Y
AD
Shifting the AD curve
P
Y
AD
1
AD
2
An increase in
the money
supply shifts
the AD curve
to the right.