Appendix B. wages. Boom Or Bust. labor. Figure B1. Feedback Loop Explanation Provided to Group L (#1)

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1 eaching Business Cycle Dynamics: A Cmparisn f Graphs and Lps 5-24 Appendix B A diagram might help visualize the sticky thery in actin. Here is mst f it: a cause-and-effect lp. A little mre will be added later. We keep it simple, adding just enugh fr ur purpse: visualizing the sticky thery. hink f this as a simplified picture -- a mdel -- f hw an ecnmy wrks. Bm We call this the Bm r Bust lp. labr Figure B1. Feedback Lp Explanatin Prvided t Grup L (#1) ake a mment t get the meaning f each term arund the lp. are paid t wrkers wh prduce gds & services Bm is a natin s ttal prductin f gds & services Sales means a natin s ttal spending n gds & services Each arrw represents a simple cause-andeffect relatinship that is explained in the next slide. Labr refers t the number f wrkers emplyed t prduce gds & services labr Figure B2. Feedback Lp Explanatin Prvided t Grup L (#2)

2 eaching Business Cycle Dynamics: A Cmparisn f Graphs and Lps 5-25 Appendix B, cntinued When things are increasing arund the lp, the ecnmy is grwing. Fllw steps 1-4 t see the Bm. An ecnmic slwdwn culd als ccur. A drp in wuld lead t declines in labr,,, and future. In ther wrds, a Bust. 3 When increases, husehld increase. Bm 4 And rising generate future spending (). When, labr,, and are steady (nt changing), the ecnmy is in equilibrium. 2 When mre labr is emplyed, prductin () increases. 1 When increase, business firms hire mre labr. labr Figure B3. Feedback Lp Explanatin Prvided t Grup L (#3) Finally, we add the urnabut lp t prevent bms and busts frm spiraling ut f cntrl. It is cntrlled by the rise and fall f inventries -- gds in stck, awaiting sale. Bm When increases, inventries rise faster. But the red arrws are different. he letter stands fr ppsite. When decrease, inventries rise faster. When inventries rise t high, business firms lwer s. inventries urnabut s When s fall, rise. labr Figure B4. Feedback Lp Explanatin Prvided t Grup L (#4)

3 eaching Business Cycle Dynamics: A Cmparisn f Graphs and Lps 5-26 Appendix B, cntinued Key Pints n the urnabut lp: When is higher than, inventries rise. When is lwer than, inventries fall. Bm When s are sticky, the urnabut lp is slw, cmpared t the Bm r Bust lp. inventries s urnabut he dashed arrw is a reminder that s are assumed t be very sticky -- averaging ne t adjust t inventry changes. labr Figure B5. Feedback Lp Explanatin Prvided t Grup L (#5) see hw the sticky thery wrks, we start in equilibrium. In equilibrium, supply () and demand () are equal. Inventries and s are stable Bm inventries urnabut he graph belw tracks changes in,, and s when they depart frm equilibrium. = lng-run trend labr Figure B6. Sticky Price hery Illustratin Prvided t Grup L (#6)

4 eaching Business Cycle Dynamics: A Cmparisn f Graphs and Lps 5-27 Appendix B, cntinued Suppse a drp in cnsumer cnfidence leads t a drp in. he graph shws the initial decline. We want t see what happens next. Sticky thery says that business firms will cut prductin befre they cut s, resulting in business cycles. Bm In the fllwing slides, let s see if this ecnmic mdel helps visualize such behavir. inventries urnabut labr drp in cnsumer cnfidence lwers initially Figure B7. Sticky Price hery Illustratin Prvided t Grup L (#7) During 1 Falling lead t less emplyed labr, lwer, and lwer. And falling cause anther drp in and a cntinued dwnward spiral. he Bm r Bust lp feeds n itself. he ecnmy shrinks. falls belw its lng-run trend. Bm Inventries must be rising since is higher than. hat s why s start falling, but slwly. inventries Sticky s slw dwn the urnabut lp, preventing it frm turning arund. urnabut labr Figure B8. Sticky Price hery Illustratin Prvided t Grup L (#8)

5 eaching Business Cycle Dynamics: A Cmparisn f Graphs and Lps 5-28 Appendix B, cntinued During 2 Prices finally fall far enugh t encurage mre spending (). Rising lead t mre emplyed labr, higher, higher husehld, and mre in the future. he urnabut lp has reversed the mmentum, and the ecnmy is grwing again. Bm inventries urnabut Even thugh exceed, mst f the inventries added during 1 have nt been sld. hus, s cntinue t fall. labr Figure B9. Sticky Price hery Illustratin Prvided t Grup L (#9) During 3 he Bm r Bust lp is feeding n itself again, but this time causing grwth. Sticky s remain lw, giving an added bst. Bm Because s are slw t adjust, the urnabut lp is slw t curb and end the bm. inventries is rising and returning t its lng-run trend. urnabut he lw s result frm excess inventries that remain high as keeps up with. labr Figure B10. Sticky Price hery Illustratin Prvided t Grup L (#10)

6 eaching Business Cycle Dynamics: A Cmparisn f Graphs and Lps 5-29 Appendix B, cntinued During 4 When will the upward mmentum slw dwn and turn arund? It depends n hw lng it takes the urnabut lp t raise s and curb spending. If the lp is slw, vershts and rises abve its lng-run trend. Sales are nw higher than, s inventries must be cming dwn. And that will put upward pressure n the sticky s. Bm inventries urnabut labr Figure B11. Sticky Price hery Illustratin Prvided t Grup L (#11) During 5 Prices finally turn up as pull inventries dwn faster than builds them up. Rising s lead t - lwer, - less emplyed labr, - lwer, - lwer husehld, and - lwer the next time arund. he urnabut lp has again reversed the mmentum f the Bm r Bust lp. Bm inventries urnabut labr Figure B12. Sticky Price hery Illustratin Prvided t Grup L (#12)

7 eaching Business Cycle Dynamics: A Cmparisn f Graphs and Lps 5-30 Appendix B, cntinued Beynd 5 dips belw its lng-run trend line, but sn rises and appraches it again. he interactin between the Bm r Bust lp and the urnabut lp will cntinue, but less dramatically each. Bm will fluctuate less and less as inventries gradually return t nrmal and s stabilize at a lwer level. inventries he business cycle will run ut f steam, and will stabilize at its lng-run trend. urnabut labr Figure B13. Sticky Price hery Illustratin Prvided t Grup L (#13) Bm Research suggests that business cycles ccur fr many reasns. Hwever, sticky s seem t cntribute t the up-and-dwn pattern. inventries Prices adjust in 12 mnths. urnabut he stickier the s, the mre fluctuates arund its lng-run trend. when s adjust in 12 mnths labr lng-run trend Bm when s adjust in 6 mnths inventries Prices adjust in 6 mnths. urnabut he quicker s adjust, the sner the urnabut lp can reverse the mmentum f the Bm r Bust lp, and stabilize at its lng-run trend. labr Figure B14. Sticky Price hery Illustratin Prvided t Grup L (#14)