Name / Keynesian Theory / Misperception Theory / Real Business Cycle Theory
What starts the recession? / A drop in AD (a decrease in C, I, G, or NX) / A drop in AD (a decrease in C, I, G, or NX) / A drop in AS (a decline in resources)
What happens in the recession? / Prices fall
Income falls
Unemployment rises / Prices fall
Income falls
Unemployment rises / Prices rise
Income falls
Unemployment rises
(stagflation)
Why does it happen? / With the drop in AD and interest rates, prices don’t full adjust downward (stickiness). This creates a surplus of goods. Companies respond by cutting production and laying workers off / With the drop in prices (macro event), companies misperceive this as a decline in demand for their good (micro event). Companies respond by cutting production and laying workers off / With the decrease in resources there are fewer goods produced in the economy. This pushes prices higher and interest rates higher.
Demand Led Expansion / Supply Led Expansion
Name / Keynesian Theory / Misperception Theory / Real Business Cycle Theory
What starts the expansion? / A rise in AD (an increase in C, I, G, or NX) / A rise in AD (an increase in C, I, G, or NX) / A rise in AS (an increase in resources)
What happens in the expansion? / Prices rise
Income rises
Unemployment falls / Prices rise
Income rises
Unemployment falls / Prices fall
Income rises
Unemployment falls
Why does it happen? / With the rise in AD and interest rates, prices don’t full adjust upward (stickiness). This creates a shortage of goods. Companies respond by increasing production and hiring more workers / With the rise in prices (macro event), companies misperceive this as an increase in demand for their good (micro event). Companies respond by increasing production and hiring more workers / With the increase in resources there are more goods produced in the economy. This pushes prices lower and interest rates lower.
1. Consumers become more confident: ( AD / AS ) will ( Inc / Dec ) which causes, in the short run, income to ( Inc / Dec ), unemployment ( Inc / Dec ), and prices to ( Inc / Dec ). This economy would be described as undergoing a (Recession / Expansion ).
2. The Government raises taxes on consumers: ( AD / AS ) will ( Inc / Dec ) which causes, in the short run, income to ( Inc / Dec ), unemployment ( Inc / Dec ), and prices to ( Inc / Dec ). This economy would be described as undergoing a (Recession/Expansion ).
3. Americans increase their purchases of I-Pods which are produced in China: ( AD / AS ) will ( Inc / Dec ) which causes, in the short run, income to ( Inc / Dec ), unemployment ( Inc / Dec ), and prices to ( Inc / Dec ). This economy would be described as undergoing a (Recession/Expansion ).
4. The price of oil and gas increases as supplies lessen: ( AD / AS ) will ( Inc / Dec ) which causes, in the short run, income to ( Inc / Dec ), unemployment ( Inc / Dec ), and prices to ( Inc / Dec ). This economy would be described as undergoing a (Recession/Expansion ).
5. The US pulls out of Iraq and military spending is cut: ( AD / AS ) will ( Inc / Dec ) which causes, in the short run, income to ( Inc / Dec ), unemployment ( Inc / Dec ), and prices to ( Inc / Dec ). This economy would be described as undergoing a (Recession/Expansion ).
6. The French increase their preference for American made cars: ( AD / AS ) will ( Inc / Dec ) which causes, in the short run, income to ( Inc / Dec ), unemployment ( Inc / Dec ), and prices to ( Inc / Dec ). This economy would be described as undergoing a (Recession / Expansion ).
7. Global warming harms agricultural production: ( AD / AS ) will ( Inc / Dec ) which causes, in the short run, income to ( Inc / Dec ), unemployment ( Inc / Dec ), and prices to ( Inc / Dec ). This economy would be described as undergoing a (Recession/Expansion ).
8. The internet increases the speed of job matching and natural rate of unemployment falls: ( AD / AS ) will ( Inc / Dec ) which causes, in the short run, income to ( Inc / Dec ), unemployment ( Inc / Dec ), and prices to ( Inc / Dec ). This economy would be described as undergoing a (Recession / Expansion ).
9. Investors become optimistic and sentiments improve: ( AD / AS ) will ( Inc / Dec ) which causes, in the short run, income to ( Inc / Dec ), unemployment ( Inc / Dec ), and prices to ( Inc / Dec ). This economy would be described as undergoing a (Recession / Expansion ).
10. For all of the above, what happens in the long run?
Income returns to the long run equilibrium or “full employment” levels. And the unemployment rate returns to the natural rate of unemployment.