Unpredictable Fluctuations AND JUST WHY They Happen

A tough economy is a mild period of falling incomes and rising unemployment, and more serious is a despair. Earlier we talked about traditional economics and traditional dichotomy and money neutrality. If the nominal variables changed, real variables still wouldn’t be changed. However, in the short-run, traditional theory will not apply. It takes time for all prices to modify always. Thus, we build the style of aggregate demand and aggregate supply.

On the x-axis is the real GDP, the quantity of output. Over the y-axis is the CPI/GDP deflator, the average degree of prices. Understand that this is not simply another supply and demand graph, this is macroeconomics. The aggregate demand curve slopes downward, but why? The purchase price level and usage (wealth impact): a decrease in price level boosts the buck value making consumers wealthier and more willing to invest, increasing volume demanded.

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The price level and investment (interest rate effect): a reduction in price level reduces interest rate (since households save more as their money will probably be worth more), and causes more investment and therefore causes greater level of goods/services demanded. The purchase price level and net exports (exchange rate effect): a reduction in price level makes the money depreciate and increases net exports, thus making the quantity of goods and services demanded increase.

Why might the aggregate demand curve shift? We discuss the aggregate supply curve Now. Over time, the aggregate supply curve is vertical because it represents a country’s real GDP and depends upon its supplies of labor, capital, and natural resources and on its available technology. This agrees with money neutrality (when price level changes, real GDP doesn’t change).

Note that brief run fluctuations in result and price level should only be viewed as deviations from continuing long term trends of output growth and inflation. How come the short term aggregate supply curve slope upwards? The short term aggregate supply curve shifts from changes in the expected price level.

A rise in the expected price level reduces the number of goods and services supplied and shifts brief tun aggregate source curve left, and this statement works conversely as well. If the aggregate demand curve shifts, for example to the left, output falls in the short run to be able to keep up equilibrium with the short run aggregate supply. Since price level has fallen below expectations, the short term aggregate supply curve shifts to the right eventually, bringing output back again to where in fact the graph began at the long term aggregate supply curve. Policy makers could shorten the recession period by trying to increase aggregate demand curve by increasing federal government spending for example.

If the short run aggregate supply curve shifts, output temporarily decreases and price level raises. A wage-price spiral could occur, where employees demand more wages as prices increase. This causes a rise in companies’ costs and makes the source curve shift even more to the left. However, this eventually prevents when the lower level of result and increased work finally make wages decrease. The change eventually then reverses another to equilibrium where output is back in the beginning at the long term aggregate supply curve. Policymakers could potentially mitigate the impact of the aggregate source curve shift by increasing the aggregate demand so that equilibrium remains at the natural rate of result (called accommodating change). This causes a rise in price level though still.