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Chapter one notes

Economist have contradictory views because they have different assumptions about how
the economy works and different time frames.

Price movement is what drives the market back to equilibrium, thus the slower the price
moves the slower it’ll take to get to equilibrium.

Classical or market clearing paradigm prices are assumed to be flexible, but in Keynesian
or non-market clearing paradigm some prices are assumed to move slowly or to be fixed.
This is why classical paradigm are assumed to work better on the long run while
Keynesian is better for the short run.

There are 4 times frames for analysis.


- Very Long run
o Growth theory is used
o Short run fluctuations such as recessions are ignored and the focus is on
how quickly the ecomony grows on average
o AS is vertical and shifting over time
- Long run
o Flexible prices and market is still in equilibrium but productivie capacity
is not changing
o AS is fixed and vertical
- Very short run
o Prices are assumed fixed
o AS curve is hortiontal
o Changes in AD will affect output only(wheras in the long run they affect
price level only)
- Short run
o Prices adjust somewhat but not fully
o AD affect both output and price level

Estimated time frames


Very short run – a few months
Short run – less then a year
Long run – 1-20 years
Very long run – 20 years or more

Very long run growth model is trying to explain growth rate averages over a long period
of time, and year-to-year fluctuations are characterize as business cycles which are
examined by short run models.

They look at:


- Consumer price index
- Unemploymenet rate
- Balance or trade(difference between inports/exports)
- Foreign exchange rate

When using models, you must always take proper care in understanding what
assumptions you are inputting into it. No single model can apply to all problems.

Two types of variables –


- endogenous variables
o are determined within the model
- exogenous variables
o are determined outside the model
all models work in this way: a change in an exogenous variable goes through the model
and changes the endogenous variable(outputs change the final result).

Sticky prices are prices that cannot adjust quickly enough to keep markets in
equilibrium(Keynesian models are sometimes called sticky price models).

Price movement phases:


Fixed – does not change
Sticky – changes slowly
Flexible – changes rapidly

The Philips curve is a measure of the speed of adjustments of prices.

Money and interest rates

Bank of Canada has two monetary policy variables


1. rate of growth of the money supply
2. level of short-term interest rate