Lecture 10

Economic Fluctuations

◼ References:
◼ N.G. Mankiw, “Principles of Economics”, 8th edition, chapters
33+34
◼ NEU, “Economics”, chapter 18

August 2022
1
A look at short-run economic fluctuations
 Explain economic fluctuations
Price
◼ Base on microeconomics Supply

◼ Demand-Supply
◼ Output, Price
Equip.
Price
◼ Derive macroeconomics
model Demand

◼ Aggregate Supply
◼ Aggregate Demand Equip. Output
Output
◼ Total Output
◼ Price level
3
Content
1. Aggregate Demand AD
2. Aggregate Supply AS
3. Equilibrium state of AD-AS

4
 1. Aggregate Demand
1. Aggregate Demand
◼ Definition: is the Total Output demanded by all
economic agents
◼ Determinants of AD
▪ Consumption C X: Export
▪ Investment I IM: import
▪ Government Spending G
▪ Net Export (NX=X - IM).
AD = C + I + G + NX. = C + I + G + X - IM
5
WHY DOES THE AGGREGATE-DEMAND CURVE
SLOPE DOWNWARD?

➢The Wealth Effect

➢The Interest-Rate Effect

➢The International Trade Effect

6
 WHY DOES THE AGGREGATE-DEMAND CURVE SLOPE DOWNWARD?

The Wealth Effect

Price level falls

Price level

Consumers feel
more wealthy
P1

P2
They spend more

Quantity of goods Y1 Y2 Quantity of

and services output
demanded rises
7
 WHY DOES THE AGGREGATE-DEMAND CURVE SLOPE DOWNWARD?

The Interest-Rate Effect

Price level falls Price

level

Households hold less money

and lend some out P1

P2

They convert their money into

interest-bearing assets

0
Y1 Y2
Interest-rate falls Quantity of
output

Quantity of goods
Firms want to borrow more and and services
spend more in investment goods demanded rises 8
 WHY DOES THE AGGREGATE-DEMAND CURVE SLOPE DOWNWARD?

The International Trade Effect

U.S Price
level falls U.S goods Both
relative to relatively less Americans
foreign price expensive and foreigners
level (exchange- than foreign buy more
rate doesn’t goods U.S goods
change)

Quantity
U.S net NX
of goods
exports
and services rises
rise
demanded
rises

9
 Causes to the shift of AD
P

C
I
P1
G
C NX
I
G AD1
AD
NX  AD1

10
0 Y1 Y* Y1 Y
 Aggregate Supply AS

◼ Definition AS
is total output of final goods and services that all
firms ready to produce and sell at a given price level
◼ Potential capacity
◼ Readiness to supply

11
 2. Aggregate Supply AS

◼ Definition AS
is total output of final goods and services that all
firms ready to produce and sell at a given price level
→ question: what determines the readiness to
produce/supply
◼ Production factors
◼ Maximization of profit

12
  The Sticky-Wage Theory:
Nominal wages are slow to adjust, or are “sticky”, in the
short run.

Wages do not adjust immediately to the price level,

a lower price level makes employment and production less
profitable, which induces firms to reduce the quantity of
goods and services supplied.

13
Short-run Aggregate Supply: ASSR
◼ Maximization of Profit
P: Price Profit = Total Revenue – Total Cost
Y: Output = P x Y – Labor cost – other costs
L: số lượng labour
W: chi cho 1 labour = P x Y – L x W – other costs
MPL = ΔY = W Marginal Propensity
ΔL P Labour
◼ Sticky-Wage theory (in short-run)

14
 W=W P rises → W/P falls → L rises → Y rises
P falls → W/P rises → L falls → Y falls

W Marginal Propensity P
P Labour
Supply
of
Goods
and
Demand Services
for Labor

L Y

15
 Short-run Aggregate Supply: ASSR
P

Prod
ASSR cost
K

P1 L
R
1. Price falls T
P2
2. Causes a fall in output
from Y1 to Y2

0 Y2 Y1 Total Output
16
 Exercise 11
◼ Explain the following situations will affect AD or AS
◼ Explain the changes in price level and GDP?
◼ Explain the new state will be recession/booming if
the initial state is long-run equilibrium?
a) The stock market declines…
b) The Federal Gov. increases spending…
c) The technological improvement…
d) A recession overseas…
17
3. Equilibrium state AD-AS

◼ What determines equilibrium state

◼ Demand Shock

◼ Supply Shock

◼ Demand shock and supply shock together

18
What determines equilibrium of
AD-AS
P
K, L, R, T, Cost
AS

Po
E0 Equilibrium

AD
C, I, G, X, IM
0 Yo Total Output
19
What determines equilibrium of
AD-AS
P
AS

Po
E0 Long-run Equilibrium

AD

0 Potential Total Output

Output
20
Y*
What determines equilibrium of AD-
AS:
When actual output is less than Potential output
P
AS

E1
P1 Recession/Depression

AD

0 Total Output
Y1 < Y* 21
What determines equilibrium
of AD-AS:
When actual output is higher than Potential output
P
AS

E2
P2
Booming/Bubble

AD

0 Total Output 22
Y* < Y2
 A demand shock causes…
2. In short-run P
P and Y fall…

AS1

P1 A

P2 B
1. Demand falls and
shifts to the left…

AD2 AD1
23
0 Y2 Y1 Total Output
 A supply shock causes
P 1. AS shifts to the left…

AS2
AS1

B
P2
A
P1
3. …and price
to rise
AD
0
Y2 Y1 Total Output
24
2. …cause total output to fall…
4. Long-run equilibrium

◼ After a shock from AD or AS

◼ There is equilibrium in goods

market but unequilibrium in labor
market

◼ Changes in wages in long run lead

to AS adjustment 25
 Case 1 AD shock to reduce

P
P reduces, Y reduces,
AS U increases

Long-run: W reduces
P
0
P
1 Production costs reduces
P
2 AD

Y1 Y0 Y AS shifts right:
Y* Y increases = Y* 26
 Case 2 AS shock to reduce

P
P increases, Y reduces,
AS U increases

P
2
Long-run: W reduces
P
0

Production costs reduces

AD

Y0 Y AS shifts right:
Y* Y increases = Y* 27
 Case 3 AD shock to increase

P
P increases, Y increases,
AS U reduces
P
2
P
1 Long-run: W increases
P
0

Production costs increases

AD

Y0 Y1 Y AS shifts left:
Y* Y reduces= Y* 28
 Case 4 AS shock to increase

P
P reduces, Y increases,
AS U reduces

Long-run: W increases
P
0
P
Production costs increases
2

AD

Y0 Y2 Y AS shifts left:
Y* Y reduces= Y* 29
 Summary for AD and AS
ASLR (given K, L, R, T)
P Production Cost
ASSR Capital K
Labour L
Natural Resources R
Technology T
E0
P0

Consumption C
Investment I
Gov. Spending G
AD Export X
Import IM

0 Y0 = Y* Y 30
 Assume that the economy is initially at the
potential output. With each of the events in
ex.10, explain the new state for the economy
ASLR (K, L, R, T)
P Production Cost
Capital K
Labour L
AS Natural Resources R
Technology T

P0 E0
Consumption C
Investment I
Gov. Spending G
Export X
Import IM
AD

0 Y0 = Y* Y 31