Econ III - Inflation, Unemployment, Output Gap

The CPI has increased by how much since 1960 ( to 2019 )

8.6 times larger

How much did CPI drop during the Great Depression 1929-1933

25%

Aside from the Great Depression what other time period saw a decline in CPI

2008 & 9 because of the Financial Crisis

How can you find the Amount of goods you can buy with $1 at any time?

1/P(CPI or GDP deflator)

If money is entered into an economy how much will the prices of goods rise by?

Increases in price will be proportional to change in money supply

what is the velocity of money

average use of a specific dollar bill in a year

what is the equation for the Velocity of Money

V (velocity) = (P(Price level) x Y(Real GDP)) / M (dollars in circulation)

In terms of P(Price Level) and Y(Real GDP) how can we find Nomial GDP

Nomial GDP = P x Y

what is the effect of increasing the Money Supply

-Makes velocity fall

-increases Real GDP

-Increases Price level

In terms of Money Velocity and Money Supply how can we find Nomial GDP

Velocity x Quantity will equal nominal GDP

Why is Inflation a bad thing?

-As inflation rises, money people have in their wallets falls -companies have to adjust prices more

-Inflation makes relative prices less accurate as not all firms will change prices at the same time which confuses consumers about the true price of goods in the future

-Credit lenders will have trouble -> increasing risk & reducing supply of savings)

what is the (NBER)

National Bureau of Economic Research

what is a Recession

if real GDP decline for 2 consecutive quarters it is a recession

what was the Worst Recession/ Depression in US history

43-month decline was during the Great Depression

How many Recessions have been longer than 12 months after WWII

3

How long do Expansions normally last?

around 2 years

How does the unemployment rate relate to the Business cycle

Unemployment rises during Expansions and falls during Expansions, there is a bit of lag time between change in Unemployment and the recessions/ Expansion

what is an Economies potential output

quantity of goods an economy can produce using its resources at a normal rate

what is the output gap

potential Output(Y*) - actual output(Y)

When the economy is under its Potential Output that means?

Unemployment rises

What happens when Actual output is over Potential output

upward pressure on inflation and wages as demand exceeds the sustainable capacity to produce goods and services

If Actual output is above potential output what can the Fed do

Fed Reserve can reduce consumption & investment spending by increasing money held in reserves by increasing interest rates

If actual output is below potential output what can the FED do

Fed can increase consumption & investment spending by decreasing the money held in reserve by decreasing interest rates

what is the natural rate of unemployment

-Unemployment from Just structural and frictional causes -Unemployment when actual output = potential output

what did the Natural rate of Unemployment rise during the 70's & 80's

-more women entered the workforce

-Alongside decline of traditional manufacturing

Who was Arthur Okun

one of JFK's chief advisors during the 60's

what is Okun’s Law

if cyclical unemployment increases 1%, the output gap aries 2%

what could cause Okun's Law to be off by a little bit

-changes in rate of potential output

-actual output is below potential

Why is there an Output gap in the Short Run

in the short-run, firms respond to variations in demand by adjusting production not price (sticky Prices)

what are Stick Prices

Prices Don't Adjust Instantly

Who said that In the short-run, firms respond to variations in demand by adjusting production not price.

John Maynard Keynes 1883-1946

What John Book did John Maynard Keynes write that summarized his beliefs

The General Theory of Unemployment, Interest, & Money (1936)

what are the 2 axis on a ASsr and AD graph?

-y axis = Price (P)

-x axis = Real GDP (Y)

what is aggregate demand curve (AD)

total quantity of all final goods and services demanded by an economy at different price levels

why does the AD curve slope downward?

-Wealth effect

-Interest Rate effects

-Foreign Effects

what is the Wealth Effect/ wealth effects and why do they make the AD curve slope downward?

If overall prices Fall the real value of money people have increases (lower prices = Cash is worth more) which increases consumption and Real GDP

What is the interest rate Effect/effects and why do they make the AD curve slope downward?

Lower prices, means that people/households will invest/ save more because they don't need as much cash for the same amount of purchases, this lowers interest rates leading to more investment by companies

What are the Foreign Effect/ effects, and why do they make the AD curve slope downward?

lower domestic Prices make domestic prices cheaper compared to foreign goods, meaning there is more domestic consumption compared to foreign consumption

Anything affecting ________ can cause shifts in the AD curve

-households/ Consumers tastes

-Government

-firm investment consumption

How could Firm Investment consumption change the AD curve

A firm investing in New Technology could cause a rightward shift in the AD curve

What is something that could cause a leftward shift in the AD Curve

stock market crash/ dip reduces Consumer confidence, leading to a leftward shift in the AD curve

How would Government Spending affect the AD curve

-When government reduce state spending it causes a Leftward shift in the AD curve

-government reduction in taxes increases consumption shifting the graph right

what is aggregate supply curve (AS^sr)

the total quantity of goods and services firms are willing to produce in the short run

why does the ASsr slope upward

because firms don't adjust prices only production ( Sticky Prices & Sticky Wages

What causes Firms to increase output instead of increase price

-when overall price rises but input prices don't rise immediately it is more profitable to change production instead of prices

what causes shifts in the ASsr Curve?

-changes in factors that Affect Production cost

-changes in Technology/ productivity

-Government regulations

-tax policy

what are some factors that affect Production cost

-changes in the expected price level

-changes in input prices

How would a Changes in the Expected price level change ASsr

-If firms expect sales to increase, there would be an upward left shift in the ASsr

-If firms expect sales to decrease there would be a downward right shift in the ASsr curve

How would changes in input prices change ASsr

-increased Input prices causes a leftward shift in the ASsr

-Decreases in Input prices causes a rightward shift in the ASsr

what are Aggregate Supply shocks

sudden unexpected events that effect firms costs

How do Aggregate Supply shocks affect ASsr

-Positive Aggregate Supply shocks cause a rightward shft in the ASsr

-Negative Aggregate supply shocks cause a leftward shift in the ASsr

how does Technology affect ASsr

lowers input costs, causing ASsr To shift to the right (also increases ASlr)

What is the Long Term Aggregate Supply curve ASlr

ASlr = Potential ouput

what are Demand Shocks affects on the AD curve

Negative Demand shocks = Leftward shifts in the Demand curve

Positive Demand shocks = rightward shift in Demand Curve

What does a Leftward shift in the AD represent

increase in the Output gap

How does an Economy Recover from a Recession?

When actual prices fall below expected, people eventually adjust their expectations which causes a ASsr curve rightward which lowers the output gap (maybe at a lower price)

What is Stagnation

-Stagnation + Inflation

-when ASsr moves up and Left

-when Price increases as well as a decreases in output

what time frame is considered "Short Run"

1 - 3 years

what characterizes a Short Run time period

-when prices are still sticky enough to causes output gap to increases

What is a downside of the Self Correcting system?

it takes a long time, leading to a period of time where life sucks

what is Fiscal policy:

usually increases spending indirectly through a tax cuts, meaning consumers have a higher disposable income (shifts AD curve right)

what is the main argument for Fiscal policy

deviations of actual output too far from potential output are costly, and Fiscal policy and cushion the negative effects and speed recovery

what is Monetary Policy

the Fed's polices that revolve around Varying money supply

How can Monetary Policy combat Depressions/Recessions

-During a Recession the fed can lower interest rates/ buying bonds which increases spending shifting AD right

what are the arguments against Monetary and Fiscal policy

-It is difficult to determine potential output and natural unemployment in real time

-Its hard to Carry out Monetary and Fiscal polices due to lags ( might end up overshooting)

what are the Different types of lags

-Recognition lags

-Decision lags

-implementation lags

what are Recognition lags

the time it takes for policy makers to realize there is a problem

what are decision lags

the time it takes for Policy makers to think of a way to stop the problem

what are implementation lags

the time it takes for polices to actually have effects in the market

How long does it take to for GDP estimates?

3 months

How much time is there between when Congress authorizes spending to the time plans are carried out

6 months - 1 year