Short-Run Economic Fluctuations

Economic activity fluctuates from year to year.

In most years production of goods and services rises.

On average over the past 50 years, production in the U.S. economy has grown by about 3 percent per year.

In some years normal growth does not occur, causing a recession.

Short-Run Economic Fluctuations

A recession is a period of declining real incomes, and rising unemployment.

A depression is a severe recession.

THREE KEY FACTS ABOUT ECONOMIC FLUCTUATIONS

Economic fluctuations are irregular and unpredictable.

Fluctuations in the economy are often called the business cycle.

Most macroeconomic variables fluctuate together.

As output falls, unemployment rises.

Figure 1 A Look At Short-Run Economic Fluctuations

Most macroeconomic variables fluctuate together.

Most macroeconomic variables that measure some type of income or production fluctuate closely together.

Although many macroeconomic variables fluctuate together, they fluctuate by different amounts.

Figure 1 A Look At Short-Run Economic Fluctuations

As output falls, unemployment rises.

Changes in real GDP are inversely related to changes in the unemployment rate.

During times of recession, unemployment rises substantially.

Figure 1 A Look At Short-Run Economic Fluctuations

EXPLAINING SHORT-RUN ECONOMIC FLUCTUATIONS

How the Short Run Differs from the Long Run

Most economists believe that classical theory describes the world in the long run but not in the short run.

Changes in the money supply affect nominal variables but not real variables in the long run.

The assumption of monetary neutrality is not appropriate when studying year-to-year changes in the economy.

The Basic Model of Economic Fluctuations

Two variables are used to develop a model to analyze the short-run fluctuations.

The economy’s output of goods and services measured by real GDP.

The overall price level measured by the CPI or the GDP deflator.

The Basic Model of Economic Fluctuations

The Basic Model of Aggregate Demand and Aggregate Supply

Economist use the model of aggregate demand and aggregate supply to explain short-run fluctuations in economic activity around its long-run trend.