Slide 0Chapter objectivesReal GDP Growth in the United StatesTime horizonsIn Classical Macroeconomic Theory,When prices are stickyThe model of aggregate demand and supplyAggregate demandThe Quantity Equation as Agg. DemandThe downward-sloping AD curveShifting the AD curveAggregate Supply in the Long RunSlide 13The long-run aggregate supply curveLong-run effects of an increase in MAggregate Supply in the Short RunThe short run aggregate supply curveShort-run effects of an increase in MFrom the short run to the long runThe SR & LR effects of M > 0How shocking!!!The effects of a negative demand shockSupply shocksCASE STUDY: The 1970s oil shocksSlide 25Slide 26Slide 27CASE STUDY: The 1980s oil shocksStabilization policyStabilizing output with monetary policySlide 31Chapter summarySlide 33Slide 34macroeconomics fifth editionN. Gregory MankiwPowerPoint® Slides by Ron CronovichCHAPTER NINEIntroduction to Economic Fluctuationsmacro © 2002 Worth Publishers, all rights reservedTopic 8:Introduction toEconomic Fluctuations(chapter 9)CHAPTER 9CHAPTER 9 Introduction to Economic Fluctuations Introduction to Economic Fluctuationsslide 2Chapter objectivesChapter objectivesdifference between short run & long runintroduction to aggregate demandaggregate supply in the short run & long runsee how model of aggregate supply and demand can be used to analyze short-run and long-run effects of “shocks”CHAPTER 9CHAPTER 9 Introduction to Economic Fluctuations Introduction to Economic Fluctuationsslide 3Real GDP Growth in the United StatesReal GDP Growth in the United States-4-202468101960 1965 1970 1975 1980 1985 1990 1995 2000Percent change from 4 quarters earlierAverage growth rate = 3.5%CHAPTER 9CHAPTER 9 Introduction to Economic Fluctuations Introduction to Economic Fluctuationsslide 4Time horizonsTime horizonsLong run: Prices are flexible, respond to changes in supply or demandShort run:many prices are “sticky” at some predetermined levelThe economy behaves much differently when prices are sticky.CHAPTER 9CHAPTER 9 Introduction to Economic Fluctuations Introduction to Economic Fluctuationsslide 5In Classical Macroeconomic Theory,In Classical Macroeconomic Theory,(what we studied in chapters 3-8)Output is determined by the supply side:–supplies of capital, labor–technologyChanges in demand for goods & services (C, I, G ) only affect prices, not quantities.Complete price flexibility is a crucial assumption,so classical theory applies in the long run.CHAPTER 9CHAPTER 9 Introduction to Economic Fluctuations Introduction to Economic Fluctuationsslide 6When prices are stickyWhen prices are sticky…output and employment also depend on demand for goods & services,which is affected byfiscal policy (G and T )monetary policy (M )other factors, like exogenous changes in C or I.CHAPTER 9CHAPTER 9 Introduction to Economic Fluctuations Introduction to Economic Fluctuationsslide 7The model of The model of aggregate demand and supplyaggregate demand and supplythe paradigm that most mainstream economists & policymakers use to think about economic fluctuations and policies to stabilize the economy shows how the price level and aggregate output are determinedshows how the economy’s behavior is different in the short run and long runCHAPTER 9CHAPTER 9 Introduction to Economic Fluctuations Introduction to Economic Fluctuationsslide 8Aggregate demandAggregate demandThe aggregate demand curve shows the relationship between the price level and the quantity of output demanded. For this chapter’s intro to the AD/AS model, we use a simple theory of aggregate demand based on the Quantity Theory of Money. Chapters 10-12 develop the theory of aggregate demand in more detail.CHAPTER 9CHAPTER 9 Introduction to Economic Fluctuations Introduction to Economic Fluctuationsslide 9The Quantity Equation as Agg. DemandThe Quantity Equation as Agg. DemandFrom Chapter 4, recall the quantity equationM V = P Y and the money demand function it implies:(M/P )d = k Ywhere V = 1/k = velocity.For given values of M and V, these equations imply an inverse relationship between P and Y:P = (M V) / YCHAPTER 9CHAPTER 9 Introduction to Economic Fluctuations Introduction to Economic Fluctuationsslide 10The downward-sloping The downward-sloping ADAD curve curveAn increase in the price level causes a fall in real money balances (M/P ),causing a decrease in the demand for goods & services.Y PADCHAPTER 9CHAPTER 9 Introduction to Economic Fluctuations Introduction to Economic Fluctuationsslide 11Shifting the Shifting the ADAD curve curveAn increase in the money supply shifts the AD curve to the right. Y PAD1AD2P = (M V) / YRise in MCHAPTER 9CHAPTER 9 Introduction to Economic Fluctuations Introduction to Economic Fluctuationsslide 12Aggregate Supply in the Long RunAggregate Supply in the Long RunRecall from chapter 3: In the long run, output is determined by factor supplies and technology,= ( )Y F K Lis the full-employment or natural level of output, the level of output at which the economy’s resources are fully employed.Y“Full employment” means that unemployment equals its natural rate.CHAPTER 9CHAPTER 9 Introduction to Economic Fluctuations Introduction to Economic Fluctuationsslide 13Aggregate Supply in the Long RunAggregate Supply in the Long RunRecall from chapter 3: In the long run, output is determined by factor supplies and technologyFull-employment output does not depend on the price level,so the long run aggregate supply (LRAS) curve is vertical:,= ( )Y F K LCHAPTER 9CHAPTER 9 Introduction to Economic Fluctuations Introduction to Economic Fluctuationsslide 14The long-run aggregate supply curveThe long-run aggregate supply curveY PLRASYThe LRAS curve is vertical at the full-employment level of output.CHAPTER 9CHAPTER 9 Introduction to Economic Fluctuations Introduction to Economic Fluctuationsslide 15Long-run effects of an increase in Long-run effects of an increase in MMY PAD1AD2LRASYAn increase in M shifts the AD curve to the right. P1P2In the long run, this increases the price level……but leaves output the same.CHAPTER 9CHAPTER 9 Introduction to Economic Fluctuations Introduction to Economic Fluctuationsslide 16Aggregate Supply in the Short RunAggregate Supply in the Short RunIn the real world, many prices are sticky in the short run. For now