the business cycle

Chapter 31The business cycle David Begg, Stanley Fischer and Rudiger Dornbusch, Economics, 6th Edition, McGraw-Hill, 2000 Power Point presentation by Peter Smith... 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

Actual output

Actual output fluctuates around this trend.

The business cycle:

short-term fluctuations of total output around its trend path

UK: growth of real GDP

The political business cycle

that there is a political business

cycle

monetary and fiscal policy soon after

an election

policies as the election approaches

to encourage a ‘feel-good’ factor

Theories of the business cycle

– 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

in output level in response to a

shock

Fluctuations in stock-building

fluctuations in output

production in the face of fluctuating demand

times of boom, and fall in times of

recession.

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.

Is there an international business cycle?

Growth in GDP, selected countries

USA UK France Italy

Source: International Financial Statistics

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

Expectations formation

 Beliefs about the future shape today’s decisions

– but how do people form expectations about the future?

Points along the macro spectrum

 New Classical macroeconomics

– instantaneous market clearing

– rational expectations

 Gradualist monetarists

– full employment will be restored within a few years

– the main effect of higher money is higher prices

 Moderate Keynesians

– 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

A stylized view of the competing views

Gradualist monetarist

Moderate Keynesian

Extreme Keynesian

Very fast

Rational – adjust quickly Not much difference Always close

No problem

Demand management useless; need

Quite fast Adjust more slowly Long run more important

Never too far away

No problem

Supply-side more important;

avoid wild swings

in demand

Quite slow

Could be fast or slow to adjust

Don’t neglect short run

Could be far away

Might be big problem

Demand management important

Very slow

Adjust slowly

Short run

v important

Could stay away

Not a big problem Demand management

is what

31.15

Chapter 33

International trade

and commercial policy

David Begg, Stanley Fischer and Rudiger Dornbusch, Economics,

6th Edition, McGraw-Hill, 2000 Power Point presentation by Peter Smith

Exports as % of GDP

0 20 40 60 80

Destination of world exports, 1996

EU 38%

Asia 28%

Africa 2%

Other 7%

Source: Direction of Trade Statistics

Some important issues

 Raw materials prices

– Less-developed countries (LDCs) have claimed exploitation by industrial countries

 e.g by buying raw materials cheaply & selling manufactures dear

 Manufactured exports from LDCs

– some LDCs have had success in exporting manufactures

– leading to complaints that jobs are under threat in the

industrial countries

 Trade disputes between industrial countries

– In some countries , established producers of certain goods are being undercut by efficient modern producers

– especially from Japan & East Asia

Comparative advantage

 Trade offers benefits when there are

international 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.

The source of comparative advantage

 An important difference between countries is in

factor endowments

 which will be reflected in different relative factor prices

– e.g if the UK has relatively abundant capital but

relatively scarce labour as compared with India,

– then the UK would tend to specialize in capital-intensive goods,

– and India would tend to specialize in labour-intensive

products

 Comparative advantage may also reflect a relative advantage in technology

Gainers and losers

specialization and trade

– but not all countries may gain equally

– is government policy that influences

international trade through taxes or

subsidies

 e.g tariffs

– or through direct restrictions on imports and exports.

The effect of a tariff

Domestic demand falls to Q d ', domestic supply rises to Q s '

and the difference is imported.

The government raises revenue – i.e there is a transfer to the government

There is a social cost from production inefficiency, given that the good could be imported at P w

There is also a loss of consumer surplus.

and there is a transfer in the form of extra profits to producers

The welfare costs of a tariff

suggests that society suffers from

this method of restricting trade.

under the GATT

– General Agreement on Tariffs and Trade

 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.

The case for tariffs – second-best arguments

 Way of life

– an attempt to preserve ‘traditional’ ways

– a production subsidy would be better

– an attempt to nurture new activities via learning by doing

– a temporary production subsidy probably better

 Revenue

– tariffs raise government revenue

– but there are better ways

 Cheap foreign labour

– a non-argument – denies benefits of comparative advantage

Other commercial policies

under GATT, there has been a

proliferation of other trade

Social costs arise from production inefficiency and consumer surplus.

Under free trade, with the world price at P w ,

Q d

consumers demand Q d

Q s

production is Q s exports are GE.

With a subsidy, producers supply Q d ' to the domestic market and produce Q s '.