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Chapter Review Chapter 29: Introduction to Macroeconomic Fluctuations

  1. Economies experience recessions and booms in which output fluctuates around its full-employment level. Recessions are periods in which real GDP declines; in booms, real GDP increases. The fluctuations in output are called business cycles.
  2. If wages and prices do not adjust quickly enough to ensure that markets are always in equilibrium, so that demand and supply are balanced, the economy may experience fluctuations in cyclical unemployment.
  3. To explain cyclical unemployment, we need to explain why the aggregate labor market does not clear. If real wages do not adjust when the demand curve for labor shifts to the left, then the quantity of labor supplied will exceed the quantity demanded at the prevailing wage and there will be cyclical unemployment.
  4. Wages may be slow to adjust because of union contracts and implicit contracts that lead to infrequent wage changes. Firms minimize total labor costs by paying the efficiency wage. Cutting wages may raise costs by lowering productivity, as the best workers are most likely to leave, or by leading to higher labor turnover costs.
  5. In the short run, firms adjust production in response to fluctuations in demand. Thus, aggregate demand plays a critical role in determining the short-run equilibrium level of output.
  6. Our model of fluctuations will be built around four key components: (1) wages are sticky, (2) prices are sticky, (3) there is a trade-off between inflation and cyclical unemployment in the short run, and (4) inflation and aggregate spending are linked by monetary policy.
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