Demand Induced Cycles

One important source of business fluctuations i! shocks to aggregate demand. A typical case is illustrated in Figure 23-4. which shows bow a decline in aggregate coriander lowers put. Say that the economy begins in short-run Equilibrium at point B. Then, perhaps because of a decline in defense spending or tight money, the” aggregate demand curve shifts leftward to AD If there is no change in aggregate supply. the economy will reach a new equilibrium at point C. Note that output declines from Q to Q’. In addition, prices are lower than they were at the previous equilibrium. and the rate of inflation falls.

The case of a boom is. naturally, just the opposite Here the AD curve shifts to the right. output approaches potential GDP or perhaps even overshoots it and prices and inflation rise.

Business-cycle fluctuations in output, employment and prices are often caused by shifts in aggregate demand. These occur as consumers. businesses, or governments change total spending relative to the economy’s productive capacity. When these shifts in aggregate demand lead to sharp business downturns, the convector suffers recessions or even depressions. A sharp upturn in economic activity can lead to inflation.

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