In-Depth Notes on Macroeconomic Fluctuations

Macroeconomic Fluctuations

Aggregate Supply and Demand

  • Goals of the Chapter:

    • Explain determinants of aggregate supply (AS) in long run vs short run

    • Explain determinants of aggregate demand (AD)

    • Understand determination of real GDP and price levels

    • Analyze economic growth, inflation, and business cycles

    • Review major schools of thought in macroeconomics

Aggregate Supply (AS)
Quantity Supplied and Aggregate Supply

  • Quantity Supplied: Total quantity firms aim to produce over a period.

  • Aggregate Supply (AS): Relation between quantity of real GDP supplied and price level.

  • Key Time Frames:

    • Long-run Aggregate Supply (LAS)

    • Short-run Aggregate Supply (SAS)

Long-Run Aggregate Supply (LAS)

  • Definition: Relationship between quantity of real GDP supplied and price level when real GDP at potential GDP.

  • Characteristics: LAS curve is vertical at potential GDP, indicating independence from price levels.

Short-Run Aggregate Supply (SAS)

  • Definition: Relationship between quantity supplied and price level when factors like nominal wage rate remain constant.

  • Characteristics: SAS curve is upward sloping; increase in price level leads to increased quantity supplied.

  • Mechanism: When price level rises without a change in nominal wages, firms can hire more labor at cheaper real wages, increasing production.

Changes in Aggregate Supply

  • Factors Affecting AS Other Than Price Level:

    • Changes in Potential GDP

    • Changes in Nominal Wage Rate and other Factor Prices

Changes in Potential GDP

  • Potential GDP increases when:

    • The full-employment quantity of labor rises.

    • There is growth in capital (physical or human).

    • Advances in technology are made.

  • Result: LAS and SAS curves shift rightward.

Changes in Money Wage Rate and Other Factor Prices

  • Increase in nominal wage rate leads to a decrease in SAS curve, shifting it leftward, while LAS remains unchanged.

Aggregate Demand (AD)

  • Definition: Total amount of final goods/services produced in Canada that is planned to be purchased.

  • Formula: Y = C + I + G + (X - M)

    • Where C = consumption, I = investment, G = government expenditure, X = exports, M = imports.

Influences on Aggregate Demand

  1. Price Level

  2. Expectations

  3. Fiscal Policy and Monetary Policy

  4. World Economy

Aggregate Demand Curve

  • Indicates the relationship between quantity of real GDP demanded and the price level.

  • Characteristics: AD curve slopes downward due to:

    • Wealth Effect: Change in purchasing power affects spending behavior.

    • Substitution Effects: Interest rate and price-sensitive consumption changes.

Changes in Aggregate Demand

  • Change in buying plans (not related to price level) can increase or decrease AD.

  • Expectations: Expectations about future economic conditions can impact current consumption and investment.

  • Fiscal Policy: Adjustments in taxes, transfer payments, and government spending can affect AD.

  • Monetary Policy: Changes in money supply and interest rates influence AD by affecting spending levels.

  • World Economy Impact: Foreign exchange rates and foreign income affect exports and imports, hence influencing AD.

Economic Fluctuations

  • Short-Run Macroeconomic Equilibrium: Occurs where quantity of GDP demanded equals quantity supplied at intersection of AD and SAS curves.

  • If GDP is above or below equilibrium, firms will adjust production and pricing accordingly to restore equilibrium.

Long-Run Macroeconomic Equilibrium

  • Defined where real GDP equals potential GDP at the intersection of AD and LAS curves.

  • Adjustment Mechanism: In cases of below-full employment, wages adjust, shifting SAS right until equilibrium is restored.

Business Cycle and Economic Growth

  • Business cycles arise from fluctuations in AD and SAS; money wages adjust slowly, affecting GDP relative to potential.

  • Economic Growth Indicators: Shift in LAS reflects growth due to labor quantity, capital accumulation, and technology advancements. Inflation can occur if money supply grows faster than potential GDP.

Schools of Thought in Macroeconomics

  1. Classical: Belief in self-regulating economy, full employment.

  2. Keynesian: Economic intervention via fiscal and monetary policy is necessary.

  3. Monetarist: Economy is self-regulating when monetary policy is stable; emphasizes steady pace of money growth.

Conclusion

Understanding these core concepts of Aggregate Supply and Demand, and their influences can aid in comprehending economic growth, inflationary trends, and potential policy responses in varying economic conditions.