Chapter 9
Introduction to Economic Fluctuations
Introduction
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The growth of real GDP is not along a smooth path.
Fluctuations around the long term growth path are called
business cycles (fig. 9-1).
Business cycles (recession, recovery, expansion) are
considered to be short-term fluctuations.
Summary of The Long Run
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Prices are flexible.
Real output are at the natural rate.
Classical dichotomy where there is neutrality of money.
Key Features of the Short Run
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Prices are assumed to be fixed at some predetermined
level.
Real output needs not be at the natural rate.
Monetary and fiscal policies which influence aggregate
demand can induce short-term changes in output.
A Simple Model of Aggregate Demand and
Supply
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The Quantity Theory as an aggregate demand (fig. 9-2):
 MV
= Py, (V = 1/k) or
 P = (MV)/y.
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Shifts in the AD curve:
A
decrease in M or V will shift the AD curve to the left (fig. 9-3).
 An increase in M or V will shift the AD curve to the right (fig. 94).
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The long run vertical aggregate supply curve (fig. 9-5).
The classical dichotomy and monetary neutrality in ADAS framework (fig. 9-6)
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The short run horizontal aggregate supply curve (fig. 9-7).
How monetary policy can induce short-run change in real
output (fig. 9-8).
Adjustment from the short run to the long run (fig. 9-9, fig.
9-10).
Stabilization Policy
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Both AD and AS are subject to exogenous shocks.
Stabilization policy is public policy designed to keep
output and employment at their natural rates.
Shocks to Aggregate Demand
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A positive shock to AD shifts it to the right. In the short
run, output is beyond its natural level. In the long run,
only price level will have increased and the economy
returns to the natural rate of output (fig. 9-11)
The Fed can offset this by decreasing M.
Shocks to Aggregate Supply
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Supply shock alters the cost of production, and as a result,
the prices that firms charge (fig, 9-12).
Examples are:
 natural
disasters such as droughts, floods
 A regulations such as environmental regulations
 Changes in minimum wage law, etc..
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Example of an adverse supply shock which results in
stagflation (fig. 9-12).
How the Fed can accommodate an adverse supply shock
(fig. 9-13).
The cost of the accommodation policy is a permanently
higher price level.
The End
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Please review the chapter.