2. Explaining Business Cycle Fluctuations with the Classical Model Outline: 1.The business cycle: again. 2.Cyclical fluctuations as an equilibrium phenomenon Shifts of labor supply Shifts of labor demand 3.Cyclical fluctuations as a disequilibrium phenomenon Labor union truculence Wage legislation

3. Recessions are shaded

8. Our next slide will illustrate a recession that results from a shift of the labor supply (L S ) schedule. Notice this is an equilibrium situation in that both actual and potential GDP change.

9. $ Real Wage Employment (millions) $ Real GDP A LDLD LS1LS1 100 R $15 $7 Trillion 0 0 B $17 Z LS2LS2 92 $6.5 Trillion

10. Some economists believe that fluctuations of real GDP and employment can be explained by shifts in the supply of labor—but they are in the minority.

11. Our next slide will illustrate a recession that results from a shift of the labor supply (L D ) schedule. Again notice this is an equilibrium situation in that both actual and potential GDP change.

12. $ Real Wage Employment (millions) $ Real GDP A LD1LD1 LS1LS1 100 R $15 $7 Trillion 0 0 $13 Z LS2LS2 92 $6.5 Trillion B LD2LD2

13. Economists of the 1930’s viewed the Depression as a “non-market clearing”, disequilibrium phenomenon. That is, “frictions” in the labor market were causing the wage to get stuck above its equilibrium value.

14. $ Real Wage Employment (millions) $ Real GDP A LSLS LS1LS1 100 R $15 $7 Trillion 0 0 Wage is stuck at $17 Now we Have a GDP Gap = $.5 Trillion $17 92108 92 $6.5 Trillion Excess Supply

15. Firms may have to pay minimum starting wages and benefits under the terms of collective bargaining agreements with the UAW, Teamsters, UMW, USW, UTW, or other major unions. Federal law stipulates minimum wages and contributions for social insurance.