Jose Rizal Essay

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Business Cycle Theory: The economy goes through temporary ups and downs over time. This behavior is called the “business cycle”. The temporary decrease in business activity and fall in income is called a “recession”. Temporary boom times are called “expansions”. There are numerous theories about why business cycles occur. The book lumps them into two main categories: supply led and demand led. I break down the demand led into two different theories. The book does characterize two different types supply led recessions: one based on a long run AS shift and the other based only on the short run AS shift. I do only one type of supply shift, long run AS. The AS/AD model: The Aggregate Supply and Aggregate Demand model is used to help explain business cycles. The basic model combines elements from the market for loanable funds (chapter 8), market for money (chapter 11 and 12), and theory of production (chapter 7). To understand the model, you need to understand the basic shapes of the curves and what would cause the curves to shift. Aggregate Demand Curve The AD curves slopes downward. The reason the AD curve slopes down is more complicated than why a typical microeconomic demand curve slopes down. In microeconomics, a demand curve slopes down showing that as price rises, people will want to buy less (or, as price falls, people will want to buy more). The microeconomic argument is that as a good gets expensive, consumers will switch, or substitute, to other goods. This theory won’t work in the macroeconomic world of AD. The problem is there is no “other goods” in the macro world. The AD curve is the demand for ALL goods. Also, in the micro world, as the price of a single rises, other prices are not changing. But in the macro world, we look at the price of all goods. So as prices rise in the macro economy, there is no other cheaper

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