1. Principles of Macroeconomics Lecture 4 BUSINESS CYCLES AND AGGREGATE DEMAND

2. Aims - To describe the short-term fluctuations in output, employment and prices that characterize business cycles in market economies - To explain the concept of aggregate demand and the differences from a single commodity demand

3. Business Cycles -are swings in total national output, income and employment, - are marked by widespread expansion or contraction in many sectors of the economy, -occur in all advanced market economies, and - consist of four phases.

4. The Business Cycles Theory

5. Business Cycles Phases and Turning Points PHASES -Expansion: A period in which GDP increases for two consecutive quarters -Recession: A period in which GDP declines for two consecutive quarters TURNING POINTS - Peak: The highest point of the expansion phase - Trough: The lowest point of recession phase

6. Business Cycles Phases - Characteristics of Expansion: - Consumption rises - Business inventories decrease - Production is increased - Real GDP rises - Business investment rises - Labour demand increases and unemployment falls - Inflation becomes high - Interest rate rises

7. Business Cycles Phases - Characteristics of Recession: - Consumption falls sharply - Business inventories increase - Production is reduced - Real GDP falls - Business investment falls - Labour demand falls and unemployment rises - Inflation slows - Interest rate falls

8. Definition of Aggregate Demand - Aggregate Demand (AD) is the total or aggregate quantity of output that is willingly bought at a given level of prices - It has four components: - Consumption - Investment - Government Purchases - Net Exports - Remember the GDP equation : Y= C+I+G+ (X-M)

9. Differences of AD with the micro demand - AD curves relate overall spending on all components of output to the overall price level - AD is downward sloping mainly due to the money-supply effect. That is when a rise in the price level occurs, the real money supply is reduced (all others held constant). Thus interest rates rise, credit is difficult to obtain and total real spending falls.

10. The Aggregate Demand (AD) Curve

11. Factors affecting Aggregate Demand -Monetary and fiscal policy -Exogenous variables such as foreign economic activity, technological advances and shifts in asset markets - Changing these variables shifts the AD curve

12. Movements and Shifts in AD

13. Factors affecting Aggregate Demand Key things to remember: -A change at the price level leads to a MOVEMENT along the AD curve - A change in other underlying factors of AD leads to a SHIFT of the AD curve

14. Macroeconomics

15. A Shift in Aggregate Supply According to Classical theory, an increase in AS increases GDP, and lowers the price level.

16. Helpful reading Economics. Samuelson, & Nordhaus (2005) Ch. 23