chapter 5.0, 5.1, 5.2 Flashcards
(30 cards)
how can the evolution of real GDP can be decomposed in
- the evolution of real GDP over time can be decomposed in:
→ potential/trend GDP growth
→ business cycle fluctuation around this trend
what is the potential GDP?
- (=real GDP at full employment) meuaseres the production that the economy is able to generate on a sustained basis
- in practice, potential GDp growth is not completely stable
- economists estimate potential GDP based on historical patterns and data on capital stock, labour
participation and other structural features of the economy
what is the output gap?
- the difference between the observed GDP and potential GDP
→ positive output gap→ economy is working above potential, meaning that is producing more than what would be expected given its underlying structural features
→ negative output gap → economy is working below potential and unemployment tends to be high
for a person to be considered unemployed, which criteria does she have to follow?
- without work
- seeling work, i.e. has made specific efforts to find a job within a reference period
- currently available to work
→ some unemployment is a necessary consequence of economic growth
explain some shortcomings of the official uneployment rate
- does not include marginally attached workers → people who are available and willing to work but currently are neither working nor looking for work (ex:discouraged workers) - inactive
- does not include involuntary part-time workers → people whor are working part-time but would like to find full time work - employed
- does not count underemployment, in which a worker accepts a lowe-quality job than they desire - employed
explain the unemployment- statistical definition
population is divided into:
- the working age population: number ofpeople aged 15 years and older who are not in jail, hospital, or some other institution
* people in labour force - people employed and people looking for a job (unemployed)
* inactive people
- people too young to work or in institutional care
how to calculate the participation rate, employment rate and the unemployment rate?
- participation rate = (labour force/working-age population) * 100
- employment rate = (number of employed / working-age population) *100
- unemployment rate = number of unemployment / labour force) *100
explain the unemployment- economic definition
Unemployment can be classified into three types:
- Frictional unemployment → arises from normal labour market turnover (the process of matching
workers and jobs)
* Permanent and healthy phenomenon of a growing economy
* Scarcity of information is one of the causes of frictional unemployment.
- Structural unemployment → lasts longer than frictional unemployment
* Number of jobs available is insufficient to provide a job for everyone who wants one
→ Created by changes in technology that change the skills needed to perform jobs
→ Minimum wages, unions and efficiency wages
- Cyclical unemployment
* Unemployment correlated with the business cycle: higher than normal at a business cycle
trough and lower than normal at a business cycle peak
* A worker who is laid off because of a recession and is then rehired when the expansion
begins experiences cyclical unemployment
* Cyclical unemployment can increase or decrease dramatically over a matter of months.
what is natural unemployment?
= frictional + structural
- unemployment that arises from frictions and structural change when there is no cyclical unemployment
- the underlying rates of frictional and structural unemployment change only slowly through time as major, long-lasting features of the economy change
- the natural unmeploment rate changes over time and is influenced by many factors
* agr distribution of the population
* scale of structural change
* labour market institutions (unemployment benefits, minimum wage laws, employment protection laws)
what is full employment?
- defined as the situation in which the unemployment rate equals the natural unemployment rate
- when the economy is at full employment, there is no cyclical unemployment
explain the differences between natural an cyclical unemployment
- over the business cycle, the output gap and the employment gap fluctuate in tandem
- when the output gap is positive the economy is working above full employment, so the employment gap tends to be positive (unemployment is low)
- when the output gap is negative, the employment gap is negative (unemployment high)
explain the differences between the short-run and the long-run in the prices
- LR
prices are flexible and responde to changes in supply or demand - SR
prices are sticky (many prices are fixed at some predetermined level)
→ prices change more frequently for food and other commodities than for services
wages are also sticky (wages also tend to move infrequently)
→ firms are very reluctant to cut nominal wages (it affects workers motivation) and sometimes even face legal constraints to doing so
→ facing reduced demand, firms that cannot cut pay to mantain margins may instead decide to reduce output and sack workers - changing prices is costly…need to change catalogues or contracts (menu costs)
→ theres costs are more relevant when average inflation is low
what is aggregate supply (AS)? mention the LR and SR
- the quantity of real GDP supplied is the total quantity that firms plan to produce during a given period
→ dependes on labour, capital and technology - aggregate supply is the relatioship between the quantity of real GDP supplied and the price level
-LR AS
real GDP=potential GDP
→ potential GDP id independent of the price level
LR aggregate supply curve is vertical at potential GDP
-SR AS
to capture price-stickiness, we assume that the short-run aggregate supply curve is flat
why is the LRAS vertical?
output is independent of prices in the LR.
- bc as the price level rises, wages change by the same percentage, real wages remain constant, the quantity of real GDP supplied remains at the potential GDP and unemployment at the natural rate
why is the SRAS flat?
price is marked-up over average costs
how do aggregate supply shifts?
- LRAS shifts with changes in potential GDP, which may increase for 3 reasons
→ increase in the full emplyment quantity of labour
→ an increase in the quantity of capital (physical or human)
→ an advance in technology - SRAS shifts with changes in production costs
→if production costs increase, SRAS curve shifts up (LRAS does not change)
explain the aggregate demand (AD)
- quatity of real GDP demanded is the total amount of final goods and services produced in a country that people, businesses, governments, and foreigners plan to buy
AD = C + G + I + NX
- the AD curve defines the relationship between the quantity of real GDP demanded and the price level (everything else constant)
Why does the AD curve have a negative slope?
- wealth effect
→ a rise in the price level, other things constant, decreases the quantity of real wealth → demand decreases (as people try to restore their real wealth) - intertemporal substitution effect (liquidity effect)
→ a rise in the price level, other things constant, decreases the real value of money and raises the interest rate
→ when the interest rate rises, people save more, so the quantity of real GDP demanded decreases - international substitution effect
→ a rise in the price level, other things constant, increase domestic prices relative to foreign prices
→ hence, imports increase and exports decrease, which decreases the quantity of real GDP demanded
what causes the AD curve shifts?
- expectations
→ Higher expected income increases C today → AD ↑
→ Higher expected income increases C today → AD ↑
→ An increase in expected profits boosts firms’ investment → AD ↑ - the world economy
→ An increase in foreign income increases the demand for Portuguese (EU) exports → AD ↑
→ A depreciation lowers the price of domestic goods and services relative to foreign goods and services,
which increases exports and decreases imports → AD ↑ - fiscal policy: government spending or changes in taxes
→ Increase in government expenditure → AD ↑
→ A tax cut or an increase in transfers => increases households’ disposable income => increases consumption expenditure → AD ↑ - monetary policy: changes in the quantity of money or the interest rate
→ An increase in the quantity of money increases liquidity → AD ↑
→A cut in interest rates → higher C and I → AD ↑ - a change in any influence on buying plans other than the price level changesaggregate demand
→ expectations
→ the world economy
→ fiscal policy or monetary policy - when AD increases, the AD curve shifts rightward
-when the AD decreases, the AD curve shifts leftward
explain the AS-AD short run equilibrium
hypothesis: fixed price equilibrium
- equilibrium occurs at the intersection of the AD curve and the SRAS curve
- in the short run real GDP is “demand determined”
- the price level is determined by the supply side (nominal wages and other costs)
- at equilibrium there is no unintended inventory investment
explain the AS-AS in the LR equilibrium
hypothesis: fully-flexible prices
- equilibrium occurs when the real GDP equals potential GDP, i.e. when the economy is on the LRAS curve
- LR equilibrium occurs at the intersection of the AF, SRAS and LRAS curves
explain what happens if there is a supply shocks (cost shocks) in the SR
- an increase (decrease) of production costs
→ price increase (decreases)
→ output declines (increases) in the SR - output id determined by AD
explain what happens if there is a demand shocks in the SR
- an exogenous reduction (increase) of AD (e.g. shock in M, G or Y*)
→ in the short-run, only output decreases (increases)
→ prices are unaffected (determined by SRAS)
→ output id determined by AD
→ the model captures the stylized fact that the changes in AD impact output faster than they impact prices
explain the supply and demand shock on the LR adjustment if real GDP is above its potential
- there is a positive output gap: an inflationary gap
- unemployment below natural rate
- pressure for nominal wages to increase
- SRAS shifts up → P increases
- demand decreases gradually along the AD curve and so does GDP and employment, until the LR equilibrium is restored
