Global Economic Environment Session 3.

GDP: Short Term Fluctuations

Professor Dezs

Note: Economics: An Introduction & Vocabulary (sections 2 & 3)

Note: The AS/AD Model

Main point:
Countries GDPs typically deviates from their long-term trends. Fluctuations in GDP
come from changes in either or both aggregate supply (AS) and aggregate demand (AD)
(and sometimes from changes in the trend itself). Shifts in either AS or AD result in
changes in output (and implicitly employment) and prices.

Terms:
Aggregate supply: function relating the total supply of all goods and services in an
economy to the general price level
Aggregate demand: function relating total demand for all good and services in an
economy to the general price level

Conclusions:
1. A countrys GDP deviates from its overall average due to shocks to AS and/or AD
but mostly AD

2. Price acts as a shock absorber for shifts in either or both AS & AD

3. Price increase (inflation) is detrimental because it introduces uncertainty into the

economy.
- costs of expected inflation: inefficient allocation because prices are
inaccurate making appropriate choices more difficult
- costs of unexpected inflation: (1) random redistribution: loans specify a
nominal interest rate; if inflation goes up more (less) than expected the
debtor (lender) benefits, (2) fixed income concerns: if income is not
indexed (COLA), income experiences uncertain fluctuations

4. Both inflation and fluctuations in GDP make consumers uncertain about consumption
and industry uncertain about investment decisions, leading to delays in consumption
and investment that decreases demand, which in turn harms the economy

5. Government typically intervenes to prevent the economy from reaching a point where
market forces are unable to correct the economy