CE

Macroeconomic Dynamics and Policy Responses

  • Technology Advances

    • Technology improvement is essential for discovering mineral deposits.
    • It influences potential output, which reflects what can be sustained over time when the economy operates at natural unemployment levels.

  • Potential vs. Actual GDP

    • Potential GDP: Represents the sustainable level of output in the long run.
    • Actual GDP: Fluctuates due to various economic cycles.
    • Concern stems from periods when actual GDP drops below potential GDP, potentially leading to increased unemployment.

  • Aggregate Demand (AD)

    • AD is represented as a downward-sloping curve affected by consumption, investment, government spending, and net exports.
    • Reasons for its downward slope include:
    • Wealth Effect: When prices fall, purchasing power increases, leading to more consumption.
    • Interest Rate Effect: Lower price levels lead to lower interest rates which incentivize more borrowing and spending.
    • External factors like pessimistic forecast or significant infrastructure spending also shift AD left or right.

  • Short Run Aggregate Supply (SRAS)

    • SRAS is upward sloping, indicating that production increases when prices rise in the short run.
    • Factors influencing the position of SRAS include:
    • Sticky Prices/Wages: Wages and prices adjust slowly to changes in demand.
    • Production factors like labor, capital, and technology influence the SRAS as well.

  • Price Expectations and Output

    • Discrepancies between expected and actual price levels affect production decisions:
    • When actual prices exceed expectations, firms increase output due to perceived higher profit opportunities.
    • Conversely, falling actual prices relative to expectations reduce output as profit margins decline.

  • Expectations Adjustment

    • Expectations adjust over time, especially following notable price level changes.
    • An upward adjustment in expected price levels can shift SRAS left, while a downward adjustment can shift it right.

  • Economic Equilibrium

    • Equilibrium occurs when actual output aligns with potential, and expected prices match actual prices.
    • Disturbances such as shifts in AD cause a new equilibrium, leading to inefficiencies like increased unemployment during downturns.

  • Role of Government in Economic Fluctuation

    • In events of reduced consumption and investment, government spending can counterbalance the drop, helping to stabilize the economy and reduce unemployment.
    • The government can undertake infrastructure projects during economic downturns to maintain or boost aggregate demand.

  • Consequences of Economic Shifts

    • An increase in expected prices can destabilize the economy, leading to wage demands that outpace productivity, causing inflation and stagnation simultaneously (stagflation).
    • The relationship between wages and prices can escalate in a cycle, creating a wage-price spiral, resulting in persistent inflation if not controlled.

  • Macroeconomic Policies

    • The impact of fiscal policy (government spending) versus monetary policy (interest rates) can be pivotal during economic shifts.
    • Policymakers need to balance unemployment reduction with inflation control, recognizing that efforts to lower one can raise the other.

  • Conclusion

    • Understanding how expectations shape aggregate supply and demand is critical in managing economic health.
    • Policymakers play a vital role in influencing these dynamics to stabilize the economy and minimize the human costs of economic fluctuations.