PART 10. ECONOMIC FLUCTUATIONS. 29. AS-AD and the Business Cycle. CHAPTER. 1. 2. 3. 4. C H A P T E R C H E C K L I S T. When you have completed your study of this chapter, you will be able to.
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AS-AD and the Business Cycle
4C H A P T E R C H E C K L I S T
Define and explain the influences on aggregate supply.
Explain how fluctuations in aggregate demand and aggregate supply create the business cycle.
Figure 29.1 summarizes U.S. recession, expansion, and cycle length since 1854.
Recessions have shortened.
Expansions have lengthened, and complete cycles have lengthened.
Figure 29.2(a) shows the recent cycles in real GDP.
Recessions began in mid-1990 and in first quarter of 2001.
The longest expansion in U.S. history ran from the March 1991 to March 2001.
When real GDP decreased in the recession (part a),
The unemployment rate increased (part b).
And a little later, the inflation rate decreased (part c).
As real GDP increased back toward potential GDP, the unemployment rate fell toward the natural unemployment rate and the inflation rate fell.
Figure 29.3 shows the aggregate supply schedule and aggregate supply curve.
Each point A to E on the AS curve corresponds to a row of the schedule.
1. Potential GDP is $10 trillion and when the price level is 110, real GDP equals potential GDP.
2. If the price level is above 110, real GDP exceeds potential GDP.
3. If the price level is below 110, real GDP exceeds potential GDP.
Point C at the intersection of the potential GDP line and AS curve is an anchor point.
1.An increase in potential GDP shifts the potential GDP line rightward and ...
2. The aggregate supply curve shifts rightward from AS0 to AS1.
Figure 29.5 shows the effect of a change in the money wage rate.
A rise in the money wage rate decreases aggregate supply and the aggregate supply curve shifts leftward from AS0 to AS2.
A rise in the money wage rate does not change potential GDP.
Figure 29.6 shows the aggregate demand schedule and aggregate demand curve.
Each point A to E on the AD curve corresponds to a row of the schedule.
The quantity of real GDP demanded
1. Decreases when the price level rises.
2. Increases when the price level falls.
Figure 29.7 shows changes in aggregate demand.
Figure 29.8 shows the aggregate demand multiplier.
1. An increase in investment increases aggregate demand and increases income.
2..The increase in income induces an increase in consumption expenditure, so
3. Aggregate demand increases by more than the initial increase in investment.
Suppose that the price level is 120 and that real GDP is $11 trillion, at point E.
The quantity of real GDP demand is less than $11 trillion and firms cannot sell all they produce, so they cut production and lower prices.
Suppose that the price level is 100 and that real GDP is $9 trillion, at point A.
The quantity of real GDP demand exceeds $9 trillion and firms cannot meet the demand for their output, so they increase production and raise prices.
Macroeconomic equilibrium occurs when the price level is 110 and real GDP is $10 trillion.
Three possible macroeconomic equilibriums are
1.Below full-employment equilibrium, when potential GDP exceeds equilibrium real GDP.
2.Full-employment equilibrium, when equilibrium real GDP equal potential GDP.
3.Above full-employment equilibrium, when equilibrium real GDP exceeds potential GDP.
Fluctuations in aggregate demand bring fluctuations in actual real GDP around potential GDP.
In year 1, real GDP equals potential GDP. The economy is at full employment.
In year 2, at a business cycle peak, real GDP exceeds potential GDP. The economy is operating at above full employment.
In year 3, real GDP equals potential GDP. The economy is back at full employment.
In year 4, at a business cycle trough, real GDP is below potential GDP. The economy is operating at below full employment.
In year 5, real GDP equals potential GDP. The economy is back at full employment.
Figure 29.11 shows an oil price cycle.
A rise in the price of oil decreases aggregate supply and shifts the AS curve leftward to AS1.
Real GDP decreases, and the price level rises.
The economy experiences stagflation.
A fall in the price of oil increases aggregate supply and shifts the AS curve rightward to AS2.
The price level falls and real GDP increases.
The economy experiences an expansion.
Figure 29.12 shows adjustments toward full employment.
Real GDP exceeds potential GDP — there is an inflationary gap —and the price level rises.
As the money wage rate gradually rises, aggregate supply decreases, real GDP decreases, and the price level rises farther.
Potential GDP exceeds real GDP—recessionary gap— and the price level falls.
Eventually, the money wage rate starts to fall, aggregate supply increases, real GDP increases, and the price level falls farther.
Consider the U.S. economy right now.
Using the knowledge you have accumulated over the course and information you have read in the current news, do you think real GDP is currently above, below, or at potential GDP?
Talk to your class mates about where they see the U.S. economy right now. Is there a consensus?
What are the main pressures on AS and AD right now?
Do you think that real GDP will expand more quickly or more slowly over the coming months?
Will the gap between real GDP and potential GDP widen or narrow?