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Transcript of Slides are prepared by Dr. Amy Peng, Ryerson University Chapter Five Output, Business Cycles, and...
Slides are prepared by Dr. Amy Peng, Ryerson University
Chapter FiveChapter FiveOutput, Business Cycles, Output, Business Cycles,
and Employmentand EmploymentMacroeconomics by Curtis, Irvine and BeggMacroeconomics by Curtis, Irvine and Begg
Canadian Edition, Canadian Edition, McGraw-Hill Ryerson, 2007McGraw-Hill Ryerson, 2007
©2007 McGraw-Hill Ryerson Ltd. Chapter 5 2
Learning Outcomes
This chapter explains:This chapter explains:• Short-run aggregate demand and supply• Equilibrium output and potential output• Changes in equilibrium output and income• Business cycles and output gaps• Okun’s Law: output gaps and unemployment
rates• Adjustments to output gaps• The role for macroeconomic policy
©2007 McGraw-Hill Ryerson Ltd. Chapter 5.1 3
A Short-Run Aggregate Demand and Aggregate Supply Model
• Short run– Constant prices for factors of production– Fixed supply of labour, capital and
technology
• The short-run AD/AS model is closely related to the national accounts framework.
©2007 McGraw-Hill Ryerson Ltd. Chapter 5.1 4
The Aggregate Demand and Supply Model
The intersection of the AD and AS shows real output measured by the expenditure approach (AD) equals to real income measured by the income approach (AS) at the price level given by the GDP Deflator 1152
117.0
AD2005
AS2005
Y = Real GDP (1997 $)
GD
P D
efla
tor
©2007 McGraw-Hill Ryerson Ltd. Chapter 5.1 5
Aggregate Demand
• Aggregate Demand (AD) is planned planned aggregate expenditureaggregate expenditure on final good and service (C + I + G + NX) at different priceprice levels
• Negative relationship – Wealth Effect– Interest rate Effect– Substitution Effect
©2007 McGraw-Hill Ryerson Ltd. Chapter 5.1 6
The Aggregate Demand Curve
• The AD curve shows planned aggregate expenditure at different prices
Y0
P0
AD
Real GDP and Income
GD
P D
efla
tor
Y1
P1
A
B
©2007 McGraw-Hill Ryerson Ltd. Chapter 5.1 7
Aggregate Supply
• Aggregate Supply (AS) is output business would produce at different price levels, all other conditions constant.
• Positive Relationship
• Unit Production Cost
Y
T
Y
CCABI
Y
WP IN
©2007 McGraw-Hill Ryerson Ltd. Chapter 5.1 8
The Aggregate Supply Curve
• The AS curve shows aggregate output as measured by real GDP at different prices
Y2
P2
AS
Real GDP and Income
GD
P D
efla
tor
Y3
P3
C
D
©2007 McGraw-Hill Ryerson Ltd. Chapter 5.1 9
Equilibrium Real GDP and Price
The intersection of the AD and AS gives equilibrium real GDP and price at A
1152
117.0
AD2005
AS2005
Y = Real GDP (1997 $)
GD
P D
efla
tor
AP0
Y1 Y0
©2007 McGraw-Hill Ryerson Ltd. Chapter 5.2 10
Equilibrium Output and Potential Output
• Short-run equilibrium is determined by AD and AS conditions.
• Potential output – Full employment output– Not the maximum output– Allow for “equilibrium unemployment”
• Actual Output
©2007 McGraw-Hill Ryerson Ltd. Chapter 5.2 11
Potential GDP
Potential GDP is the economy’s output when the markets for factor inputs are in equilibrium
Yp
P1
P2GD
P D
efla
tor
Real GDP
Yp is not affected by changes in the price level
©2007 McGraw-Hill Ryerson Ltd. Chapter 5.2 12
450000
550000
650000
750000
850000
950000
1050000
1150000
1250000
1975 1978 1981 1984 1987 1990 1993 1996 1999 2002 2005
Year
mill
ion
s 19
97$
Recession Recession
Recovery and Boom
Potential and Actual GDP in Canada 1975-2004
Figure 5.6
Potential GDP
Actual GDP
©2007 McGraw-Hill Ryerson Ltd. Chapter 5.3 13
Business Cycles and Output Gaps
• Business cycles cause differences between actual and potential GDP
• Output Gaps measure the difference between actual and potential GDP
• Inflationary gaps and Recessionary gaps
%100Y
Y-Y gapOutput
p
p
©2007 McGraw-Hill Ryerson Ltd. Chapter 5.3 14
The Output Gap in Canada, 1985-2005
-7
-6
-5
-4
-3
-2
-1
0
1
2
3
1985-Q1 1988-Q1 1991-Q1 1994-Q1 1997-Q1 2000-Q1 2003-Q1
Year and Quarter
Pe
rce
nta
ge
of
Po
ten
tia
l GD
P
Figure 5.7
©2007 McGraw-Hill Ryerson Ltd. Chapter 5.4 15
Output Gaps and Unemployment Rates
%100forcelabour
employed people ofnumber -forcelabour u
Unemployment Rate (u)
%100forcelabour
employment mequilibriu-forcelabour un
Natural Unemployment Rate (un)
)Y of rategrowth -Y of rategrowth (-u p21
Okun’s Law
©2007 McGraw-Hill Ryerson Ltd. Chapter 5.4 16
Okun’s Law
A
C
B
gY1
gY2
gYp
0Δu<0 Δu>0
Gro
wth
in R
eal G
DP
Change in Unemployment Rate
At Point A
gY1 > gYp, the demand for labour inputs is growing faster than labour force, the unemployment rate falls
At Point B
gY = gYp, the demand for labour inputs is equal to labour force, the unemployment rate does not change
At Point C
gY1 < gYp, the demand for labour inputs is growing slower than labour force, the unemployment rate increases
Figure 5.9
©2007 McGraw-Hill Ryerson Ltd. Chapter 5.4 17
Okun’s LawThe Effect of Growth in Real GDP on
Unemployment
-1.5-1
-0.50
0.51
1.52
2.53
3.54
-7 -6 -5 -4 -3 -2 -1 0 1 2 3 4
% growth in Real GDP - % growth in Potential GDP
Ch
an
ge
in U
ne
mp
loy
me
nt
Ra
te
%
Application Box 5.2
Change in u rate = 0.11 – 0.4234 (growth in Y – growth in Yp)
©2007 McGraw-Hill Ryerson Ltd. Chapter 5.2 18
Equilibrium Unemployment
• Frictional unemployment– entry and exit of workers– workers changing jobs
• Structural unemployment – mismatch between skills/experience of
supply of labour and skill/experience requirements of employers (labour demand)
©2007 McGraw-Hill Ryerson Ltd. Chapter 5.2 19
Cyclical Unemployment
• NAIRU – nonaccelerating inflation rate of unemployment
• Recessionary output gap– reduced demand for labour– cyclical unemployment
• Inflationary output gap– increased demand for labour– cyclical “over” employment
©2007 McGraw-Hill Ryerson Ltd. Chapter 5.5 20
Adjustments to Eliminate Output Gaps
A recessionary gap results in lower wage rates and other factor prices. AS shifts down, and equilibrium output increases to eliminate the gap.
Y0
P0
AD0
AS0
Real GDP
GD
P D
efla
tor
P1
AS1
Yp
Recessionary gap
©2007 McGraw-Hill Ryerson Ltd. Chapter 5.5 21
Adjustments to Eliminate Output Gaps
A inflationary gap raises factor prices and costs. AS shifts up, and equilibrium output decreases to eliminate the gap.
Y0
P0
AD0
AS0
Real GDP
GD
P D
efla
tor P1
AS1
Yp
Inflationary gap
©2007 McGraw-Hill Ryerson Ltd. Chapter 5.6 22
The Role for Macroeconomic Policy
• Why are output gaps, especially recessionary gaps, persistent?– The flexibility or rigidity of wage and prices
• Can government policy work to eliminate output gap?– Fiscal Policy– Monetary Policy
©2007 McGraw-Hill Ryerson Ltd. Chapter 5 23
Chapter Summary
• The Aggregate and Supply model provides a framework for our study of operation of the economy– Aggregate Demand– Aggregate Supply– Short-run Equilibrium Real GDP and Price
• Potential outputPotential output is the economy’s output at full employment level
• Business CyclesBusiness Cycles are short-run fluctuations of actual real GDP around its potential
©2007 McGraw-Hill Ryerson Ltd. Chapter 5 24
Chapter Summary
• Output GapsOutput Gaps are the differences between actual real GDP and its potential
• Okun’s LawOkun’s Law makes a link between output gaps and unemployment rate
• Inflationary Gaps and Recessionary GapsInflationary Gaps and Recessionary Gaps • Actual output adjustsadjusts to potential output over
time if factor prices are flexible• Fiscal and Monetary policyFiscal and Monetary policy are tools
government and monetary authorities use