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Business Cycles

Business Cycles. Spring 2014. US Real GDP (Quarterly series). Real GDP Turkey. Real GDP in Turkey. Growth rate of Real GDP in Turkey. What to do about it recessions?. Alternative 1:

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Business Cycles

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  1. Business Cycles Spring 2014

  2. US Real GDP (Quarterly series)

  3. Real GDP Turkey

  4. Real GDP in Turkey

  5. Growth rate of Real GDP in Turkey

  6. What to do about it recessions? • Alternative 1: Do nothing; it will come to back to Potential Output, (long run level of output but it may take a long time) • Alternative 2: Do economic policy to correct the business cycles.

  7. Why? What to do about it?‘Schools of Thought’ Historical Perspective • Classical View (until 1930s Great Depression) • Keynesian View (recovery of Great Depression) Recent Perspective • New Keynesians • Monetarist Model • The New Classical Model • Real Business Cycles

  8. Keynesian View • Flow of demand for goods and services vs. • Flow of supply of goods and services determines equilibrium in GOODS AND SERVICES MARKET

  9. Keynesian Macroeconomics • Aggregate Expenditure (aggregate demand) vs. • Aggregate Supply

  10. ‘Desired’ Aggregate Expenditures • Buyers in the Goods Market: • Desired Consumption Expenditures, • Desired Investment Expenditures, • Desired Government Expenditures, • Desired Net Exports

  11. What determines the desired AE? • AEd= Cd + Id + Gd + Xd – Md • Household: Cd depends on Disposable Income. • Firms: Id depends on cost of borrowing. • External Sector: Xd and Md depends on exchange rate and Income. • Government: determines its own expenditure level Gd (it is a policy tool).

  12. Equilibrium in a Macroeconomy Keynesian Model: (emphasizes the demand side) • If AEd > Y , then there is unplanned decline in the inventory levels of the firms, firms start to increase production. • If AEd=Y , then there is no unplanned change in inventory levels,no change in production (Equilibrium). • If AEd < Y , then there is unplanned increase in the inventory levels of the firms, firms start to decrease production.

  13. Equilibrium in a Macroeconomy • Graphical Presentation of equilibrium:

  14. Disequilibrium adjustment • If the economy starts at a point where AE≠Y; what happens? The forces in the economy will bring the economy to the equilibrium output level. (Stable equilibrium) • If for example AE<Y… then inventories will pile up, the firms will cancel orders, firms will cut back production, fire workers, employment and production will decline until AE=Y. (Reverse is also true for AE>Y )

  15. Why does the Equilibrium Income change? • If any of the autonomous spending increase then equilibrium income will increase from YE to YENEW. • Possible causes of autonomous income increase are: • (Graphically all of these are vertical (upward) shift of the AE function)

  16. How does the Equilibrium Income change? Example: If Investment increases from to (where ) Then

  17. How does Eq. Income respond to a change in AEd? • What is the change in equilibrium income if Id increases? • ( ) • Multiplier: Numeric example…

  18. Why is there a ‘multiplier effect’? • Initial increase in autonomous spending sets off a series of increase in AE and in real GDP. • First increases, which means firms want to purchase more new machines, the AE in the economy increases, the factories which makes these machines will hire workers. This will increase their salary payments, the workers will increase their desired consumption and hence the economy will move to a higher Y level along the new AE function.

  19. How does the multiplier work?

  20. Multiplier • For one unit increase in the autonomous desired expenditures the equilibrium income increases by a multiple amount. • The formula for the multiplier: • The steeper the slope of AE function, the larger will be the multiplier.

  21. Why do we need the multiplier information? • If Desired Government Expenditure increase by 1 billion TL, we can tell what will be the change in the equilibrium income i.e.(Multiplier x 1 billion TL) • Hence we will be able to tell how much increase in desired government expenditure is necessary to bring the economy to Potential Real GDP level.

  22. Potential OutputIdeal level of income • What is an ideal level of Real GDP? POTENTIAL INCOME (Full employment level of income) • The income level that corresponds to the output that will be produced if all resources are employed at a ‘normal’ rate. • Here, the output level is at the Natural Rate of Unemployment, (U% is equal to only frictional + structural U% rate, and cyclical U% equal zero.).

  23. Output Gap = YPotential – YE • Graphically Output Gap

  24. Necessary change in Government expenditures to close the Output Gap • ∆Y= multiplier*∆G • Hence you may compute the necessary change in change in G from the above equation, as • ∆G= ∆Y/ multiplier

  25. What if the government increases taxes by 1 Billion TL • Is the effect on Real GDP ( Equilibrium income) expansionary or contractionary? ??? • How much will be the change in Real GDP? ???

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