1. Chapter 9: Introduction to Economic Fluctuations

2. Business Cycle
Changes in the level of economic activity. Real GDP has grown at an average rate of 3% per year in
But, growth has not been smooth:
Recession: , ,
Boom: , ,

3. Time Horizon in Macroeconomics
Long run: a time period in which prices are flexible and can respond to changes in demand and supply. Prices respond to policy changes.
Short-run: a time period in which prices are “sticky” at some predetermined level. Prices do not respond to policy changes.

4. Aggregate Demand
The relationship between the quantity of output demanded and the price level
Money market equilibrium
Money demand for transaction: (M/P) = kY
Money supply = M/P
Equilibrium: M/P = kY where k is a constant

5. Aggregate Demand Line Price level
An increase in the price level (P) reduces the real
money balances (M/P), which lowers the quantity
demanded for goods and services. AD
Output, Income

6. Shift in Aggregate Demand
An increase in the money supply (M) makes the real money balances (M/P) to go up, which increases the level of the AD (this is a shift to the right)
An decrease in the money supply (M) reduces lower the real money balances (M/P), which decreases the level of the AD (this is a shift to the left)

7. Shift in Aggregate Demand
Price level
Increase
AD2
Decrease
AD1
AD3
Output, Income

8. Aggregate Supply
The relationship between the quantity of output supplied and the price level
Long-run AS is a vertical line because of complete price flexibility assertion
Short-run AS is a horizontal line because of price inflexibility assertion

9. Aggregate Supply Long-run AS Short-run AS P Y Price level Price level
Output, Income
Output, Income

10. Shift in Aggregate Demand
In the short-run, a higher AD results in
a greater output at a constant price level.
Price level
SRAS
AD2
AD1 Y1 Y2
Output, Income

11. Shift in Aggregate Demand
In the long-run, a higher AD results in
a higher price level at a constant output.
Price level
LRAS P2 P1
AD2
AD1 Y
Output, Income

12. Aggregate Equilibrium
Price level
LRAS P
SRAS AD Y
Output, Income

13. Effect of Stabilization Policy
An increase in the money supply stimulates the investment demand, causing AD to increase
Short-run effect: An increase in the level of output (point A moves to point B)
Long-run effect: The rise in income increases the demand for goods, resulting in higher prices. As prices rise, output falls to its natural level (point B moves to point C)

14. Effect of Stabilization Policy
Results of expansionary policy:
Short-run: output growth
Long-run: higher price level
Price level
LRAS C A B P
SRAS
AD2
AD1 Y
Output, Income

15. Effects of a Supply Shock
An increase in the production cost, reduces the short-run AS
Short-run effect: A decrease in the level of output and a higher price level (point A moves to point B)
Long-run effect: The decline in income decreases the demand for goods, resulting in lower prices. As prices fall, output rises to its natural level (point B moves back to A)

16. Effects of a Supply Shock
Results of supply shock:
Short-run: output decline and price increase
Long-run: higher price level
Price level
LRAS B
SRAS2 A P
SRAS1
AD1 Y
Output, Income

17. Accommodating Supply Shock
The offset the short-run output decline, the central bank can increase the money supply to shift the AD up
The long-run effect is a permanent price increase

18. Accommodating Supply Shock
Price level
LRAS C
SRAS2 A
SRAS1
AD2
AD1 Y
Output, Income