Macroeconomics Chapter 7-8

The cyclical behaviour of the economy over time
Business cycles are not regular cycles; they are irregular and vary in the size of fluctuations
Recessions and expansions are difficult to predict
Business cycles involve most or all of the economy (not just certain sectors)

The economy is growing at a rate below normal-Unemployment rises sharply in a recession and typically declines more slowly (often very slowly)-Recessions usually see a fall in inflation; some but not all recessions are preceded by a rise in inflation.

The economy is growing at a rate above normal

Measures the amount of GDP (output) when resources (capital and labour, technology) are being used at normal rates.- AKA full-employment GDP- denoted Y*
(the growth rate of potential GDP depends upon the growth rates of the inputs to production (e.g. capital, labour, productivity); periods of high or low GDP growth may reflect changes in the growth rate of Y*)

When Output Y does not equal potential output Y*
Recessionary Gap: Y* - Y > 0; output is below potential output.
Expansionary Gap: Y* - Y < 0; output is above potential output.

1. Frictional - looking for work; looking for workers (job matching takes time).2. Structural - workers lack skills or need to re-locate3. Seasonal - regular seasonal unemployment4. Cyclical - unemployment due to recessions

= frictional + structural + seasonal unemployment; - - denoted u*.

U - u*(total unemployment - natural rate of unemployment)
- Cyclical unemployment varies closely with the output gap.- Recessionary Gap: a rise in u - u*- Expansionary Gap: a fall in u - u*

100 x ((Y* - Y) / Y*)  = 2 x (u - u*)- An estimate of Y* and Okun's Law gives us an estimate of u*; and vice versa

Objective: to set down a simple model of aggregate demand that explains departures from potential(full employment) output.- J.M. Keynes.Critical assumption: in the short run rms meet the demand for their products at preset prices

It is costly to change prices; in the short-run it may be best to set prices and meet demand.

- At any point in time, consumers, rms, and governments have expenditure plans; what theywould like to spend given current conditions.
Y = C + I + G + NX PAE = C + I^p + G + NX PAE = C + c(Y - T) + I^p + G + NX

I = I^p + unplanned inventory investment

Y - PAE = I - I^p = unplanned inventory investment

Consumption Function:
C = C + c
(Y - T)
- C is the autonomous or exogenous component of consumption spending. - c is the marginal propensity to consume (MPC) out of disposable income, Y T. (0 < c < 1, the MPC is less than one)