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0:01
[Music]
0:23
A fairly recent company to the global marketplace, Federal Express, makes a tidy example of the effects of business size and success based on the Aggregate Supply and Aggregate Demand model, known as the AS-AD model. The value of packages handled by FedEx is about 4% of U.S. GDP and 1.5% of global GDP. Some analysts use a "FedEx Indicator" to gauge the state of the economy because FedEx's business rises and falls along with GDP.
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As the United States entered a recession in December 2007, firms and households cut back on shipping packages. In the first quarter of 2008, FedEx reported its first loss after 11 straight years of profits. By September 2009, economic conditions improved, and so did FedEx's profits. By 2013, many FedEx customers had begun shipping by ocean freight, which decreased the demand for the company's air cargo services. To understand how the business cycle affects
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FedEx and other firms, we need to explore the effects that recessions and expansions have on production, employment, and prices.
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Stocks posting games today this coming after three days of losses and Deborah Koster reports from the floor of the New York Stock Exchange with the latest details Deborah thanks a lot Tim yes stocks rallying and shooting up to really here in the last few minutes as well of course we saw this rally all day today and the would the speculation today is the Japan will be containing that nuclear crisis and once again the headlines coming out fast and furious as TEPCO getting a lot more help today to
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deal with that situation but most traders do say the market was probably just a little bit oversold here and for the first time in five days the Japanese ETF was higher even though the Nikkei was down 1.4 percent of course traders tell me the events overnight here will dictate how we close out this week and what the trading will be like tomorrow FedEx also helping out today sentiment that's not climbing the most since July and they predicted higher profits this
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quarter FedEx of course seen as a proxy for the economy pin well Deborah with what's going on in Japan and higher gasoline prices was any we're really surprised by what FedEx had to say today in its report you know actually pin some analysts were actually very surprised because of the problems in Japan and the potential for the higher fuel prices very surprising to hear that FedEx is so optimistic but here's the deal FedEx sees an increase
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the import business from Japan and they also see an increase in traffic into Japan for the reconstruction and speaking of the movement of cargo take a look at Hawaiian Holdings this is the parent company of Hawaiian Airlines they transport cargo and also passengers that stock lower once again for a second day and of course, Hawaii is kind of wondering how it will deal with a significant drop in the two billion dollars that Japanese visitors were
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projected to spend there this year why is already seeing several thousand tour and hotel cancellations from the Japanese market and Japan is the second largest source of visitors behind the US mainland and that means of course a lot of lost revenue for core Hawaii that's it from here Pam now back to you thank you very much Deborah constant reporting from the New York Stock Exchange. We take a fresh approach to the standard aggregate demand and aggregate supply model.
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There is no good, simple alternative to using the aggregate demand and aggregate supply model when explaining movements in the price level and real GDP. The key problem, of course, is that Aggregate Demand and Aggregate Supply is a static model that attempts to account for dynamic changes in real GDP and the price level.
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My approach retains the basics of the AD-AS model but makes it more accurate and useful by making it more dynamic. I emphasize two points: 1. Changes in the position of the short-run (upward-sloping) aggregate supply curve depend mainly on the state of expectations of the inflation rate. 2. The existence of growth in the economy means that the long-run (vertical) aggregate supply curve shifts to the right every year. The aggregate demand and aggregate supply
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model explains short-run fluctuations in real GDP and the price level. The aggregate demand, AD curve, shows the relationship between the price level and the quantity of real GDP demanded by households, firms, and the government. The short-run aggregate supply, known as the SRAS curve, shows the relationship in the short run between the price level and the quantity of real GDP supplied by firms. In the short run, real GDP and the price level are determined by the interaction of the aggregate
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demand curve and the short-run aggregate supply curve. In long-run macroeconomic equilibrium, the aggregate demand curve and short-run aggregate supply curve intersect at a point on the long-run aggregate supply curve. In short-run macroeconomic equilibrium, the aggregate demand and short-run aggregate supply curves can intersect at a point away from the long-run aggregate supply curve. This divergence can cause disruption of the normal functioning of the economy.
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We will look closely at this divergence.
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AP money minute having lost workers to rivals and other companies General Motors has restored white-collar pay that was cut last spring at that time it was desperately trying to conserve cash and unsuccessfully avoided filing for bankruptcy protection GM is guaranteeing two car buyers that if they don't like their new Chevrolet GMC Buick or Cadillac they have 60 days to return it for a full refund.
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FedEx flashing a signal the global economy is taking off it's raising its first quarter earnings forecast on better than expected international shipments and cost-cutting
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US business has reduced inventories at the wholesale level for a record 11th consecutive month in July at the same time the government says sales rose by the largest amount in more than a year sparking hope for better times ahead.
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I'm Mark Hamrick with AP
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By now, you can probably recite the GDP relationship from memory - its second nature by now, right? GDP has four components: consumption (C), investment (I), government purchases (G), and net exports (NX). If we let Y stand for GDP, we can write: Y = C + I + G + NX These components are individually, and en masse, considered when governments make fiscal and monetary policies. We can find insights to express the GDP and its effect on the price level.
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The aggregate demand curve is downward sloping because a fall in the price level increases the quantity of real GDP demanded. Current income is the most important variable determining consumption by households. But consumption also depends on wealth. When the price level rises, the real value of household wealth declines and so will consumption. The effect of the price level on consumption is called the wealth effect and is one reason
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the aggregate demand curve is downward sloping. When prices rise, households and firms need more money to finance buying and selling. Therefore, when the price level rises, households and firms will try to increase the amount of money they hold by withdrawing funds from banks, borrowing from banks, or selling assets. These actions drive up the interest rate. Because a higher price level increases the interest rate and reduces investment spending,
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it also reduces the quantity of goods and services demanded. The effect of the price level on investment is known as the interest rate effect and is a second reason why the aggregate demand curve is downward sloping. If the price level rises in the United States relative to the price levels in other countries, U.S. exports will become relatively more expensive, and foreign imports will become relatively less expensive. U.S. exports will fall, and U.S. imports will rise, causing net exports to
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fall. The effect of the price level on net exports is known as the international-trade effect and is a third reason why the aggregate demand curve is downward sloping. The aggregate demand curve tells us the relationship between the price level and the quantity of real GDP demanded, holding everything else constant. If the price level changes but other variables that affect the willingness of households, firms, and the government to spend are unchanged,
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the economy will move up or down a stationary aggregate demand curve. If any variable changes other than the price level, the aggregate demand curve will shift. Three variables shift the aggregate demand curve: 1. Changes in government policies. 2. Changes in the expectations of households and firms 3. Changes in foreign variables The federal government uses monetary policy and fiscal policy to shift the aggregate demand curve. We start with Monetary Policy as it refers
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to the actions the Federal Reserve takes to manage the money supply and interest rates to achieve macroeconomic policy objectives. We will also look into Fiscal Policy as it refers to changes by the Executive Branch of government concerning federal taxes and purchases that are intended to achieve macroeconomic policy objectives. Monetary policy is the process by which the monetary authority of a country controls the
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supply of money, often targeting an inflation rate or interest rate to ensure price stability and general trust in the currency. In the USA this is carried out by the Federal Reserve. These policies directly affect the Aggregate Demand curve by shifting the curve. When interest rates increase the AD curve shifts to the left. Increased interest rates are not a direct change to the price level immediately, so it is not a movement along the curve, it is a shift of the curve.
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Fiscal policy is the means by which a government adjusts its spending levels and tax rates to monitor and influence a nation's economy. These are the actions carried out by the executive branches of the government, like the President and Congress together. This includes actions by the government to spend money on a new highway, to fund colleges, or to bolster military capacities. It is the creation of a tax incentives program to benefit research and development, or to
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increase taxes to raise more federal revenues. Fiscal Policy is the sister strategy to Monetary Policy through which a central bank influences a nation's money supply. When the federal government increases taxes on citizens, it reduces disposable income, consumption decreases, and the AD curve shifts to the left. It was not a direct change in the price level or Real GDP, so it was not a movement along the curve. It is what is called an Exogenous variable
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change those shift the curve. With each of these, Monetary and Fiscal Policies, consider if it is a direct change in the price level and if it is not, then it may cause a shifting of the curve, to the left or right. Your challenge is to determine which direction the exogenous variable shift moves the curve.
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Remember we recently talked of consumer expectations? This can make a shift in the AD curve. When households become more optimistic about the near future, consumption may increase and cause a shift in the AD curve to the right. This is sometimes seen when the economy moves into a recovery mode of expansion following a recession. It can also make a shift to the left if consumers are convinced a recession is in progress and spending is curtailed, especially on the more expensive durable goods.
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Changes in foreign variables are expressed in relation to the movement of our domestic prices and the strength of the US dollar. When the US dollar increases in relative value to our trading partner's currency, our products become more expensive and their consumption of US goods and services decreases, causing an AD curve shift to the left. This can be expressed directly in terms of the growth rate of Real GDP between countries. These are not direct changes to the price
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levels, so it is Exogenous shift of the AD curve.
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Consider a major theme used in this class, the Great Recession 2007-09. It was a major event of our most recent time. We look closely into it so we can understand what happened and why. We start by examining Consumption at the end of the Expansionary period, totaling about 7% of GDP by value, then when the recession started in 2007 and fell faster in 2008, as a percent of a dropping GDP Consumption fell to less than 3%. It regained some of the lost impact, but still remains around 4%.
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We take a similar look into Investment to see it climbing to 7% at the end of the expansion in 2001-06, then fell to around 2% and remains at about 3% in 2016. In contrast, Net Exports appears to climb at the beginning of the Great Recession, but much of the climb was the result of the falling value of the US Dollar in comparison to the value of the currencies of our nearest trading partners. As the value of the US Dollar regained strength,
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the value of net exports, expressed as a percent of GDP, again fell and remains at about -3% of GDP. Your take away message is clear, each component of GDP responds to the business cycle. Some responses are autonomous, and some the result of Fiscal and Monetary policies to influence their impacts. We will continue to look closely at these.
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Because changes in the price level do not affect the number of workers, the capital stock, or technology in the long run, changes in the price level do not affect the level of real GDP. The level of real GDP in the long run is called potential GDP or full-employment GDP. The long-run aggregate supply, called the LRAS Curve shows the relationship in the long run between the price level and the quantity of real GDP supplied. The LRAS curve is a vertical line.
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Because potential GDP increases each year, the long-run aggregate supply curve shifts to the right each year. In the long-run, the aggregate supply curve is perfectly vertical, reflecting economists' belief that changes in aggregate demand only cause a temporary change in an economy's total output. The long-run aggregate supply curve can be shifted, when the factors of production change in quantity. The short-run aggregate supply curve is upward
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sloping because, over the short run, as the price level increases, the quantity of goods and services firms are willing to supply increases. The main reason firms behave this way is that as the prices of goods and services rise, prices of inputs rise more slowly. Most economists believe that some firms and workers fail to accurately predict changes in the price level. The reasons for this include: 1. Contracts make some wages and prices "sticky". 2. Firms are often slow to adjust wages.
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3. Menu costs, the costs to firms of changing prices, make some prices sticky. It is common practice for firms to enter into long-term supply contracts to slow future cost increases, or to make them predictable.
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Changes in real GDP occur in response to price level changes over short periods of time when input prices rise more slowly than output prices. Because real GDP responds to changes in the price level in the short run, the short-run aggregate supply curve is upward sloping. Economists use the phrases "sticky wages" and "sticky prices" to refer to the slow response of wages and other input prices, as well as some output prices, to price level changes.
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Prices at the retail outlet may go up 5% over a series of weeks, but normally, employee salaries will not change more frequently than annually, or less often. They are sticky.
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If the price level changes but other variables are unchanged, the economy will move up or down a stationary aggregate supply curve. These are the endogenous variables explained by the axes of the graph. If any variable other than the price level changes, the aggregate supply curve will shift. These are the exogenous variables explained by changes in factors outside the graphed relationship.
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The most important exogenous variables that cause the short-run aggregate supply curve to shift include: 1. Increases in the labor force and in the capital stock 2. Technological change 3. Expected changes in the future price level 4. Adjustments of workers and firms to errors in past expectations about the price level 5. Unexpected changes in the price of an important natural resource.
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We have dedicated considerable time to the topic of labor in the US economy, often expressed in the converse relationship of unemployment and if it is rising or falling. You have heard me talk of Employment Rates and the historic number of working people in the country. When that number of employable people increases and they enter the workforce, there is a shift in the short run aggregate supply curve to the right. The price level remained unchanged but the SRAS curve shifted.
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Recall the Personal Production Function from Chapter 22 and how technology can increase worker's productive capacity to shift productive capabilities upward from line 1 to line 2, 3 and 4. When this happens, it is seen as a shift in the Short Run Aggregate Supply curve to the right at all price levels. These factors introduced this semester all come back together into this SRAS and LRAS curves defining changes to Real GDP.
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When folks are all convinced that prices are climbing because of inflation at a certain rate, the price level will ultimately climb. Workers will demand more pay, retailers will inflate prices, and manufacturers will lift their prices. Expectations can become reality. When consumers expect inflation of 2% and react to the expected increased prices by reducing consumption and increasing savings while businesses react by increasing wages and the prices they charge.
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The components of inflation are established and executed and the SRAS shifts to the left.
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Now consider that maybe the expectations were unfounded, and the rate of inflation was not 2%, but was 4% instead. Compensation by consumers and businesses recognize the increased prices at 4% and businesses increase production. Increased production is matched with increased wages and the prices they charge. They play a game of catch-up and the SRAS shifts to the left.
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A supply shock is an unexpected event that causes the short-run aggregate supply curve to shift. Supply shocks are often caused by unexpected increases or decreases in the prices of important natural resources. Our economy is anchored on fossil fuels, and when the price of the commodity is unexpectedly hiked up, the economy responds with both an increased cost of operations and a reduction in output. OPEC charging $120 per barrel of crude oil
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that cost $20 several years before was realized in the USA with a shift to the left of the SRAS. It was also met with new developments in electric cars, and technologies to extract unconventional oil produced from oil shale rock fragments. These moderated the leftward shift to stabilize the disruption.
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We can use the aggregate demand and aggregate supply model to analyze changes in real GDP and the price level. In the long run, the short-run aggregate supply curve and the aggregate demand curve intersect at a point on the long-run aggregate supply curve, and the economy produces its potential level of real GDP. At this point, firms are operating at their normal level of capacity, and everyone who wants a job will have one, except for the
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structurally and frictionally unemployed. This is what we in the economy hope for, it is nirvana of economics. From here, growth is possible.
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We look into the Long-Run as this macroeconomic equilibrium continues. Assume that: 1. The economy has not been experiencing any inflation. The price level is 110 and is expected to stay at that level. 2. The economy is not experiencing any long-run growth. Though unrealistic, these assumptions allow us to understand the key ideas of the aggregate demand and aggregate supply model. Assume that rising interest rates reduce investment and cause the aggregate demand curve to shift
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to the left, resulting in a recession. The recession will eventually end because there are forces that push the economy back to potential GDP in the long run. The shift in aggregate demand lowers the price level. Workers will be willing to accept lower wages, and firms will be willing to accept lower prices. This causes the SRAS curve to shift to the right. It may take the economy several years to return to potential GDP. Economists refer to this adjustment process
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as an automatic mechanism because it occurs without any actions by the government. An alternative to waiting for the autonomous mechanism to work is for the government to use monetary and fiscal policy to shift the AD curve to the right and restore potential GDP more quickly. Give your attention to the resulting price level, the vertical axis, as we moved from a starting point at A then to B and finally to C. Through this process Real GDP settled at the
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initial point, but the price level dropped from 110 to 106.
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Consider the components of GDP as we have studied throughout this semester. Does it really matter which factor causes a drop in Real GDP? Not really, because they all interact in the balance of the health of our economy. Looking at this graph of residential construction we recognize the growth started after the 1991 recession ended converting into an expansionary period escalating this sector until about 2006. At that point, the collapse pivoted on Mortgage
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Backed Securities and a systemic failure of safeguards in the U.S. banking system that collapsed by the end of the formal recessionary period in 2009. The U.S. economy is in a recovery phase, but it is a slow progression to the rate of expansion historically witnessed in this sector. As of 2017, Housing Starts have been below the level of 800,000 units, reaching only 794,000 units per year in May 2017. When looking at the entire economy, as expressed
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by GDP, it may collapse with the cause pinned to a specific event, like the Mortgage Backed Securities fiasco of 2007-09, but really it is the combination of all factors as some may pick up during the drop and maintain a stable level of Real GDP. In the same respect, recovery moving into sustainable expansion requires all components synergistically moving together to pull expansion into a full recovery mode. If many firms become more optimistic about the future profitability of new investment,
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the resulting increase in investment shifts the AD curve to the right. Firms will operate beyond their normal capacity, and some workers who would ordinarily be structurally or frictionally unemployed are employed. An automatic mechanism will bring the economy back from a short-run equilibrium beyond potential GDP. Workers will push for higher wages, and firms will charge higher prices. As a result, the SRAS curve will shift to the left.
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The process of returning to potential GDP may last more than a year. Time is less critical than the movement into sustainable growth.
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When oil prices increased substantially, this increased many firms' costs and caused the SRAS curve to shift to the left. The price level is higher in short-run equilibrium but real GDP was lower. This result is called stagflation, a combination of inflation and recession, usually resulting from a supply shock. The recession eventually results in workers accepting lower wages and firms accepting lower prices. As this occurs, the SRAS curve will shift
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to the right. The economy returns to potential GDP at the original price level. It may take the economy several years for this process to be completed. Alternatively, the government can use monetary and fiscal policy to restore potential GDP more quickly, but this would result in a permanently higher price level.
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Now I apply these concepts to the current status of the U.S. Economy. I have talked about and shown the Consumer Price Index; the CPI as collected by the Bureau of Labor Statistics. The CPI is used as a proxy for the rate of inflation as felt by consumers. Looking into historic measures of this index, notice the drops in the CPI from month to month. Specifically look at the 2001 and 2009 troughs in the CPI as indicators of the recession.
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We see the same performance in 2015 as being more evident than the plunge and recovery of 2001, but less drastic then the 2008 plunge. Conversely, the recovery of 2015 was short lived as the CPI values again have been falling. Transitioning to the Producer Price Index, the PPI, we see a similar performance as the CPI values plummeted and recovered. Focus mostly on the drop in the price and quantity rated PPI value during each recession and the ultimate recovery of the pre-disruption PPI value.
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This is what signals a recovery in actual terms; the attainment of pre-recession values. After the 2001 event it happened when the PPI reached 140 in 2003, and in 2011 when the PPI reached 210. Current performance of the PPI is in an unrealistic trajectory as we move through 2017 and hover near 190.
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I now step you into a use of these data and the interpretation of prices in a commodity important to the USA: timber prices. By using the Producer Price Index values collected monthly, we have a measure of the economy's producer weighted factors of price and quantity. When applied to Nominal timber prices, like this one for Douglas-fir 2 Sawmill log sorts in the Western Washington log market, I am able to predict real prices for this product
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through time. The Real Price Appreciation Forecast through time is enabled by computations pulling the PPI values each month. See the early 2015 drop in Real price accompanying the drops in both the CPI and PPI at the same time. For the timber management organization, the Reserve Price Indicator features of this forecast urge the retention of the product until prices recover, at least to the level of the RPA Forecast tool's projections.
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Also make note of the 2021 line showing when these prices are forecast to level out in Real terms. We will soon revisit this date in context of the U.S. Economy's recovery projections. Remember 2021. Autonomous adjustments in the economy can happen without intervention by the Federal Reserve or the President with Congress, but they can be sped by them. In the post-Great Recession period the U.S. economy is currently in, the SRAS is settled to the left of the LRAS vertical line.
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The Real GDP is less than long-run equilibrium. We are at point B. The result has been underemployed people in the economy and a level of production below potential production. People are incentivized to accept lower wages, retail prices are depressed, and the SRAS struggles to move to the right. Eventually, the SRAS will intercept AD where the LRAS is found. The economy will return to the original price level. This is not currently happening overnight. It can take years to balance.
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Because of the combined severity of the Great Recession and the systemic complications of Fiscal and Monetary policies, this recovery is still elusive.
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Although the economy has witnessed positive job growth since 2011 at just over 189 thousand jobs per month, this rate is below the 1992-2001 job growth of 226 thousand jobs per month witnessed in that expansionary period. This job deficit of over 45 million jobs in the U.S. economy is evidence that the SRAS, AD, and LRAS curves are still out of sync.
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How long will it take for the system to be back in sync? That is a great question that several economic minds were put to the task to solve. The Federal reserve, Congressional Budget Office, and the White House Economic Advisors each attempted to evaluate these data to make projection of the length of time to recover Long-Run Equilibrium. The CBO and the White house each projected in 2011 that the economy would return to Full Employment in 2016. The Federal Reserve estimated these were too
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optimistic and would take longer. When we consider the estimates made by each group, we can see they were off by a large magnitude. You just saw the employment gap of 44 million jobs as of June 2016, but you most likely did not see that reported by the media. It is an inconvenient measurement of the economy for each of these groups to admit. This is one reason we see the 5% unemployment reported by the media to the nation. You know at this point, as a student in this
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class, that the 5% Normal unemployment assumes those unemployed persons are not in the job market any longer, and do not receive unemployment benefits.
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We look again at the Federal Reserve's projections of the length of time to recovery in the economy. Again, we look at the inconvenient evidence of the time span to recovery as being projected for late in 2021. Remember that Supply Shock graph for Douglas-fir 2 Sawmill log sort prices and the expected normalization in 2021? I made that projection in 2010 soon after the culmination of the Great Recession. The Federal Reserve saw this eventuality as an autonomous recovery in 2011.
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Lots of evidence identifies this time span as being more and more realistic. Is this a slow autonomous recovery, or are there other Fiscal and Monetary policies abating eventual stabilization of the economy?
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[Music]
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To simplify understanding of the system, I have held the price level constant, and long-run growth has been held in check. Really, we want to consider the dynamic Aggregate Demand and Aggregate Supply models. In this reality, we look at a continuously increasing level of Real GDP and a SRAS curve that moves to the right at a pace the overall economy moves with.
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An important characteristic of the dynamic aggregate demand and aggregate supply model is that potential GDP is allowed to grow continually, shifting the long-run aggregate supply curve to the right. To measure the growth of potential GDP, economists use a growth accounting model. Kevin Kliesen, an economist at the Federal Reserve Bank of St. Louis, has estimated the future growth of potential GDP for the United States using
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a simple version of a growth accounting model, or framework, published annually in the Economic Report of the President. The framework predicts potential GDP growth by adding estimates of the adult population, the participation rate of the working age population, and aggregate labor productivity. The Census Bureau predicts that the adult population will grow by 0.91% annually from 2007 to 2017, and by 0.83% from 2018 to 2028.
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The growth of the working-age population averaged about 2.3% annually from 1970 to 2006. Over the next decade, this growth rate is expected to fall to 0.65% annually, with even lower growth rates after 2018. These population changes combined with stable economic growth shifts the SRAS and AD, both the right as LRAS shifts to show growth of Real GDP. Eventual movement from Price Level A to B, in this hypothetical equilibrium maintains a constant Price Level while real GDP grows.
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Remember that we are looking specifically at equilibrium where the AD and SRAS intersect and LRAS is established. AD may shift to the right by more than the SRAS because this shift to the right indicates increased prices where AD will be decreased people demand less GDP when the price increases. If the growth is sustainable, the LRAS intersection will result in a price level increase. Moving from point A to B is the more common eventuality in a growing economy.
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In this chapter, I have discussed the interrelatedness of the factors of GDP. This measurement can readily be applied to the health of the nation's economy. When we look into the 2007-09 Great Recession, its cause is often shifted to the event of Mortgage Backed Securities and the scuttling of the housing market. This was felt in Monetary policies by the Federal Reserve, Quantitative Easing attempts, and a tightening of the credit market.
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These events were exacerbated by the Oil Price Shock from OPEC countries, amplifying crude oil prices by a factor of 5. At the same time, Fiscal policies failed in their attempts to ease financial burdens on private companies, instead decreasing Government Expenditures, and increasing tax burdens on working Americans and the American companies they work for. This tightening has insured the slow recovery path.
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Take a look at the Real GDP as measured in the US economy, as of 2016. This gap between Expected GDP and Actual GDP is indication of the imbalance in the USA economy currently. This gap appears small on this scale, but through time it has been above, below, and in equilibrium. The perpetual and struggling imbalance is indication of the need for fiscal and monetary policies to realign the health of the US economy. It is either that, or wait for the autonomous correction to be seen in about 2021.
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