the business cycle

Chapter 31 The business cycle David Begg, Stanley Fischer and Rudiger Dornbusch, Economics, 6th Edition, McGraw-Hill, 2000 Power Point presentation by Peter Smith 31.1 Actual output Actual output fluctuates around this trend. The business cycle: short-term fluctuations of total output around its trend path Time Trend output Trend output grows steadily as productive potential increases. A A – slump E E – slump again B B – recovery phase has begun C C – Boom D D – recession under way 31.2 UK: growth of real GDP -4 -2 0 2 4 6 8 1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 % change p.a. Source: Economic Trends Annual Supplement 31.3 The political business cycle  Some commentators have suggested that there is a political business cycle  whereby governments adopt tight monetary and fiscal policy soon after an election  but then adopt more expansionary policies as the election approaches to encourage a ‘feel-good’ factor 31.4 Theories of the business cycle  The multiplier-accelerator theory: – the multiplier communicates the effects of changing investment to aggregate demand – the accelerator assumes that firms gauge future demand by reference to past output growth  this model can produce fluctuations in output level in response to a shock 31.5 Fluctuations in stock-building  Stockbuilding may also be a cause of fluctuations in output  Firms tend to use stocks to smooth production in the face of fluctuating demand  Output per worker tends to rise in times of boom, and fall in times of recession. 31.6 Real business cycles  In this view of the world, fluctuations in actual output are fluctuations in potential output  … so there is no point in trying to stabilize output over the business cycle.  Although some swings in potential output do occur, many short-run fluctuations are more likely to reflect Keynesian departures from potential output. 31.7 Is there an international business cycle? Growth in GDP, selected countries -4 -2 0 2 4 6 8 10 12 14 16 1961 1964 1967 1970 1973 1976 1979 1982 1985 1988 1991 1994 1997 % p.a. USA UK France Italy Source: International Financial Statistics 31.8 Chapter 32 Macroeconomics: where do we stand? David Begg, Stanley Fischer and Rudiger Dornbusch, Economics, 6th Edition, McGraw-Hill, 2000 Power Point presentation by Peter Smith [...]... imports fall 33.24 The welfare costs of a tariff SS The tariff leads both to transfers and net social losses The government raises revenue – i.e there is a transfer to the government Pw+ T Pw DD Qs Qs' and there is a transfer in the form of extra profits to producers Qd' Qd Quantity There is a social cost from production inefficiency, given that the good could be imported at Pw There is also a loss... clear (especially the labour market) – and there is more scope for the government to influence the macroeconomy 32.11 Expectations formation  Beliefs about the future shape today’s decisions –  Exogenous expectations –  not explained within the model Extrapolative expectations –  but how do people form expectations about the future? assumes that the future will be similar to the recent past Rational... imports and exports 33.23 The effect of a tariff SS DD and SS show the domestic demand and supply for a good If the world price is Pw, and there is free trade, domestic firms supply Qs domestic demand is Qd Pw+ T Pw and the difference is imported DD A tariff can stimulate domestic Qs Qs' Qd' Qd Quantity supply and restrict imports At a domestic price Pw + T, where T is the size of the tariff Domestic demand... differences in the opportunity cost of goods Opportunity cost of a good –  the quantity of other goods sacrificed to make one more unit of that good The law of comparative advantage – states that countries should specialize in producing and exporting the goods that they produce at a lower relative cost than other countries 33.21 The source of comparative advantage  An important difference between countries... enough to affect the world price This policy fulfils the principle of targeting – – which says that the most efficient way to attain a given objective is to use a policy that influences that activity directly Policies that attain the objective, but also influence other activities are second-best, because they distort those other activities 33.27 The case for tariffs – second-best arguments  Way of... Tariffs  The deadweight burden of a tariff suggests that society suffers from this method of restricting trade  This is the case for free trade  Tariffs have fallen substantially under the GATT – General Agreement on Tariffs and Trade 33.26 The case for tariffs – good arguments  Optimal tariff – –  a first-best argument only valid where the importing country is large enough to affect the world...Macroeconomics in perspective  There is a spectrum of views about the macroeconomy – especially with regard to – market clearing – expectations formation – speed of adjustment 32.10 Market clearing  The question of whether all markets clear is critical in macroeconomics  In a Classical view of the world, all markets clear –  so the economy is at full employment and at potential... patterns of the rich in a poor society better achieved by a consumption tax Infant industries –  an attempt to preserve ‘traditional’ ways a production subsidy would be better tariffs raise government revenue but there are better ways Cheap foreign labour – a non-argument – denies benefits of comparative advantage 33.28 Other commercial policies  Although tariff rates have fallen under GATT, there has... expectations economy will eventually get back to full employment but wage and price adjustment is fairly sluggish Extreme Keynesians – – markets fail to clear in the short run and fail to clear even in the long run 32.13 A stylized view of the competing views New Classical Market clearing Expectations Long run/ short run Very fast Rational – adjust quickly Not much difference Full employment Always... Ita nc e U K Fr a B el gi um N ' la nd s 0 33.17 Destination of world exports, 1996 North America 17% Africa Other 2% 7% EU 38% Latin America 5% Middle East 3% Asia 28% Source: Direction of Trade Statistics 33.18 The composition of world exports 100% 80% 60% 40% 20% 0% 1955 Food, ag Fuels 1995 Other primary Manufactures 33.19 Some important issues  Raw materials prices – Less-developed countries (LDCs) . election  but then adopt more expansionary policies as the election approaches to encourage a ‘feel-good’ factor 31.4 Theories of the business cycle  The multiplier-accelerator theory: – the multiplier. p.a. Source: Economic Trends Annual Supplement 31.3 The political business cycle  Some commentators have suggested that there is a political business cycle  whereby governments adopt tight monetary. production in the face of fluctuating demand  Output per worker tends to rise in times of boom, and fall in times of recession. 31.6 Real business cycles  In this view of the world, fluctuations