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CHAPTER 8 -- Part 2: THE BUSINESS CYCLE
The amount of money people need to borrow is affected by the price level.
Consumer borrowing needs are smaller at lower prices.
Interest rates decline as the demand for loans decreases.
More borrowing and loan-financed purchases are stimulated by this "cheaper" money.
The downward slope of the aggregate demand curve is reinforced by these interest-rate effects.
Our production possibilities are determined by available resources and technology.
Changes in the price level affect their supply decisions.
The chance to make a profit is the main motivation for supplying goods and services.
Producers can earn a profit if the prices they receive for their output exceed the costs they pay.
If the price level goes down, profits go down.
Rent, interest payments, negotiated wages, and inputs already contracted for are some of the costs that producers are saddled with in the short run.
If output prices fall, producers will not be able to make a profit.
The rate of output will be reduced.
Higher output prices have a different effect.
Higher prices for goods and services tend to widen profit margins because many costs are relatively constant in the short run.
Producers will want to sell more goods as profit margins increase.
The profit effect depends on the costs remaining constant.
Not all costs will stay the same.
Cost increases may be caused by tight supplies of other inputs.
As time goes on, even costs that initially stayed constant may start to go up.
Producing output will be more expensive because of cost pressures.
If prices rise at least as fast as costs, producers will be willing to supply more output.
The cost of producer prices is shown by the upward slope of the aggregate supply curve in Figure 8.6.
The aggregate supply curve almost turns straight up at high output levels.
These curves have special significance.
Some important clues about the economy's performance can be found in the summaries of buyer and seller behavior.
The behavior of buyers and sellers is compatible at this point.
Buyers and sellers are willing to trade the same amount of supply.
If there was another price or output level, the significance of macro equilibrium would be appreciated.
Producers will have to reduce their prices to sell these goods.
Producers will reduce the volume of goods sent to the market.
Consumers will seek to purchase more quantities.
If a lower price level existed, the adjustment process would be the same.
The aggregate quantity demanded would be more than the aggregate quantity supplied.
The sellers would be able to raise their prices.
The aggregate quantity demanded would decrease and the aggregate quantity supplied would increase.
It's the only price-level-output combination that is compatible with aggregate supply and demand.
It's the only place where the aggregate supply and demand curves intersect.
The behavior of buyers and sellers is compatible.
The price and output combinations are not stable.
There are two possible problems with the equilibrium depicted in Figure 8.7.
Our goals may not be satisfied by the equilibrium price or output level.
The designated macro equilibrium may not last very long.
Both buyers and sellers' intentions are compatible with the level of prices and output established by equilibrium.
Our policy goals may not be satisfied by these outcomes.
The intersection of two curves is depicted in Figure 8.7.
The contingency is illustrated in Figure 8.8.
We didn't achieve our goal of full employment.
Problems may arise from the equilibrium price level.
Full employment and potential GDP are represented.
The price level will rise if market behavior determines it.
It could be argued that our apparent macro failures are just an artifact.
We would have both price stability and full employment at that intersection.
We can draw curves on the graph.
That is the kind of economic outcome shown in Figure 8.8.
Figure 8.8 is just the beginning of our worries.
Suppose that the AS and AD curves intersect in the perfect spot.
Imagine that equilibrium yielded optimal levels of employment and prices.
Even a perfect macro equilibrium doesn't guarantee a happy ending.
The AS and AD curves are not locked into their positions permanently.
Whenever the behavior of buyers and sellers changes, they will.
The price of oil was increased by the Organization of Petroleum Exporting Countries.
A decrease in aggregate-supply curve tends to reduce GDP and raise aggregate demand.
Higher export demand, changes in expectations, higher taxes, natural disasters, changes in tax policy, or other events may result in a supply shift.
The terrorist strikes against the World Trade Center caused a leftward shift of aggregate supply.
Fear of further terrorism kept some producers out of the market.
Supplying goods and services to the market increased due to increased security of transportation systems and buildings.
The impact of a leftward AS shift on the economy can be seen in Figure 8.9.
Full employment and price stability are no longer with us.
The aggregate demand curve could be shifted.
Americans were worried about their physical and economic security after 9/11.
Consumers were afraid to shop at the mall and board airplanes.
Businesses were afraid of starting new projects.
The slow recovery of confidence kept the AD curve from shifting back to the right in a timely manner.
The situation gets even more crazy when the aggregate supply and demand curves change in different directions.
A leftward shift of the aggregate demand curve can cause a recession.
A later rightward shift of the aggregate demand curve can cause a recovery.
Similar upswings and downswings can be caused by shifts in the aggregate supply curve.
There are 500 unused and unwanted passenger jets and they are brand new in the desert.
Most of the excess is cut profit to keep their factories busy.
In Dallas, Raleigh-Durham, N.C., and San Francisco the process is longer.
The best explanation can be found in the fall, when the recovery is weaker than expected.
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Goods remain unsold, workers are laid off, and prices fall.
The classical economists were not worried.
They believed the economy would gravitate towards full employment.
Keynes was worried that the equilibrium might start out badly and get worse without government intervention.
The AS/AD model doesn't resolve the controversy.
It provides a framework for comparing theories about how the economy works.
Any desired equilibrium could be attained with the right shape or shift.
There are differing opinions as to how this happy outcome might come about.
Demand-side explanations, supply-side explanations, or some combination of the two are what these differing views are.
The demand-side theories include Keynesian theory.
Keynes believed that a deficiency of spending would hurt the economy.
Unemployment may be caused by insufficient demand.
The lack of spending would leave goods unsold and production capacity unused.
Keynes concluded that high unemployment was caused by inadequate aggregate demand.
Keynes developed his theory during the Great Depression, when the economy seemed to be stuck at a very low level of equilibrium output.
He argued that the only way to end the Depression was for someone to demand more.
He advocated a big hike in government spending to start Cyclical Instability.
His advice was mostly ignored.
Keynes advocated changing government taxes and spending in times of peace to shift the aggregate demand curve.
Money plays a role in financing aggregate demand.
Money and credit affect the willingness of people to buy things.
Consumers won't be able to buy as many expensive products if credit isn't available.
Business investment might be affected by tight money.
Lower interest rates and an increase in the money supply may help shift the AD curve into the desired position.
Aggregate demand is considered a prime suspect for inflationary problems by both Keynesian and monetarist theories.
All of our successes and failures are attributed to the money supply.
Changes in the money supply and shifts of aggregate demand will affect the price level.
We'll look at the basis for this view in a moment.
A different explanation of the business cycle is shown in Figure 8.11.
Aggregate demand is stationary, while aggregate supply shifts.
Aggregate supply may be responsible for downturns.
In The U.S. Bureau of Economic rising costs, in resource shortages, or in government taxes and regulation, that unwillingness may be the result of simple greed.
Domestic product may be limited by data on gross investment in infrastructure or skill training.
Data from ply potential is being used.
Employment will not be achieved with the demand AD 0 if the aggregate supply curve is AS 1 rather than AS 0.
Multiple macro problems can be caused by a decrease in aggregate supply.
Everyone blames either the demand side or the supply side.
Various shifts of the aggregate supply and demand curves can achieve any output or price level.
Some economists think that the various theories of short-run instability are pointless.
In their view, month-to-month or quarter-to-quarter fluctuations in real output or prices are statistical noise.
The classical theory states that the economy will self-adjust.
The economy will return to its long-run equilibrium growth path once producers and workers make required price and wage adjustments.
There is a similar view of long-run stability in the monetarist theory.
The monetarist theory states that the supply of goods and services is determined by the size of the labor force and technology.
The long-run aggregate supply curve is not sloped.
Figure 8.12 shows a view of long-run stability.
The classical and monetarist theories claim that if the long-run AS curve is really vertical, some startling conclusions will follow.
The profit effect is an incentive to increase output.
Workers will demand higher wages, landlords will increase rents, and banks will charge higher interest rates as the price level rises.
Classical economists use the AS curve to explain how the economy adjusts to setbacks.
In the Great Depression, people waited for 10 years and didn't see any self-adjustment.
It's in the short run that we must consume, invest, and find a job.
Short-run variations in macro outcomes will determine how well we fare in any year.
Short-run macro outcomes are influenced by aggregate supply and aggregate demand.
Competing economic theories achieve a standoff by distinguishing between short-run and long-run aggregate supply curves.
The importance of short-run macro outcomes is emphasized in theories that highlight the necessity of policy intervention.
Voters want "Washington" to fix the problem if inflation or unemployment is too high.
Natural stability of the market points to the predictability of long-run outcomes.
They prefer to let the economy self-adjust rather than risk government intervention.
The duration of acceptable "short-" and "long-" run periods remains controversial even if true.
The AS/AD model shows how the macro economy works.
The model raises more questions than it answers.
Macro equilibrium is determined by the intersection of the AS/AD curves.
There are different theories about how to tame the business cycle.
We need to establish our goals and policy options as we explore those theories.
There are many different outcomes in Figure 8.4.
The first step in policy development is to decide which outcomes are most worrisome.
We have to establish priorities.
A policy strategy is being adopted.
A strategy for achieving the policy goal must be formulated after the goal is established.
The aggregate demand curve should be shifted.
Policy tools can be used to increase or decrease total spending.
The aggregate supply curve should be shifted.
Policy levers that reduce the cost of production can be found.
Don't get in the way of the market.
The first two strategies assume that government intervention is needed to tame the business cycle.
Policy tools should be selected.
There are a number of different policy tools that can be used to implement an AS/AD strategy.
Classical economists don't require any tools for the laissez-faire strategy.
Classical economists relied on the self-adjustment mechanisms of the market to bring an end to recessions.
This approach was rejected by Keynes.
He wanted to use the federal budget as a policy tool.
Spending more money can shift the AD curve to the right.
Consumers will have more income to spend if taxes are cut.
The government can change the curve by cutting spending or raising taxes.
The hallmark of fiscal policy is the use of gov budgetary tools.
The budget is one of the tools in the interventionist tool box.
The AD curve can be changed by interest rates and money supply.
Lower interest rates make it easier for consumers to buy big-ticket items like cars, homes, and appliances.
The AD side of the macro outcomes are fixed with fiscal and monetary tools.
There are tax incentives in the supply-side tool box.
International trade and money flows can be used to shift the ability and willing aggregate supply and demand.
A reduction in trade barriers makes imports cheaper.
The aggregate supply is shifted to the right to reduce price pressures.
Changing the international value of the dollar affects the relative price of U.S.-made goods.
Trade policy is one of the tools in the macroeconomic toolbox.
Getting it right.
There are a lot of tools in the macro-policy toolbox.
There are still heated arguments about which tool to use.
The policy tools are examined more closely in the following chapters.
Hopefully, we'll get some more clues about how to tame the business cycle tomorrow.
3 percent a year is not enough for the market-driven macro equilibrium.
3 employment or price goals are not increased by output.
Every year, macro failure occurs.
In some years, the economy's equilibrium isn't optimal.
Growth is slower in other years.
Changes in output may affect equilibrium.
The focus of macroeconomics is illustrated by the shifts of the AS and AD curves.
A new equilibrium is formed when macro theory explains.
Competing economic theories try to explain the business cycle while macro policy tries to control it.
The primary outcomes of the economy are output and demand.
The AS curve tends to be vertical in the long run because of the interplay of internal market forces and policy levers.
Macro outcomes are sensitive to both supply and aggregate demand because of all the influences on them.
laissez faire is the classical of output and prices.
The economy will gravitate to that approach in order to shift the unique combination of output and price levels.
The stock market fell on September 11.
There are numerical and graphing problems in the Student Problem Set at the back of the book.
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