Final Topic 13 Flashcards
Economic Implications of when all markets are in equilibrium
- GDP at full employment
- GDP determined by product approach and we focus of economy’s aggregate supply (Y* = AF(K,N) , with N=N*)
- Long run interest rate follows from the funds market only.
- All prices of goods and services (including nominal wages) are flexible.
- Monetary policy with money supply changes is neutral in LR with flexible prices.
business cycle
time interval between on peak and the next peak. Recurrent but not periodical (can happen and an expansion is followed by a contraction but it is not clear when they will occur and when short-run fluctuations in economic activities turn).
economic short run
described by a situation in which at least one endogenous variable of the economic model cannot change and is hold fixed.
economic short run occurs if prices…
if prices of goods and services or nominal wages are sticky.
Short run equilibrium for current economic model is described by the following conditions
- equilibrium in the goods market but output may not be at full employment such that Ysr = AF(K, Nsr) = C+I+G(+NX).
- Labor market may not clear: Nsr >, =,< N*
- Equilibrium in funds market with S (sr) = I (sr) and r (sr) for a closed economy or with CA (sr) = S (sr) - I (sr) and r (world) for an open economy.
- equilibrium in assets market with real money supply equal to real money demand, but with P~ = P* and r = r (sr) for a closed economy and r=r(world) for an open economy).
economic implications of short-run equilibrium conditions
- GDP may not be at full employment. (Ysr < Y* or Ysr>Y*)
- GDP follows the expenditure approach and we focus on the economy’s aggregate demand. Ysr = C + I + G + NX. Labor market may not be in equilibrium (NsrN*)
- Real interest rate can differ from the long-run equilibrium interest rate such that r(sr) > r* or r(sr)
Classical perspective
prices of goods and services adjust immediately (very short time) to external shocks and that the economy moves immediately from one long-equilibrium to the next long-run equilibrium. Focus is on the product approach (often referred to as “supply side economics”)
Keynesian perspective
prices of goods and services do not adjust immediately. an economy (especially the labor market) can be out of equilibrium for longer periods of time. Focus on the expenditure approach (referred to as ‘demand side economics’).
which side is right and how do we know?
an empirical question. we have to know 1. how fast markets and their prices adjust to shocks and 2. how severe the effects of short-run fluctuations impact long-run economic trends…
in order to motivate government interventions.
excess demand for NM assets
P of NM assets goes up, leading to r going down (return on NM assets).
aggregate demand curve
illustrates the relationship between price level and real output demanded. (P and Y)
Real money supply
Ms / P
Real money demand
L(.)
Intuition behind P going down, real money supply going up (Ms/P), and real interest rate going down
when real money supply goes up, there is an excess supply of money, which is equivalent to an excess demand in NM assets, causing the price of NM assets to go up. The increased prices decreases the returns of NM assets and makes the r go down.
relationship between price level and real interest rate
positive relationship (p goes up, r goes up)
