Explaining Business Cycle Fluctuations with the Classical Model

1
Explaining Business Cycle Fluctuations with the
Classical Model

• Outline
• The business cycle again.
• Cyclical fluctuations as an equilibrium
  phenomenon
• Shifts of labor supply
• Shifts of labor demand
• Cyclical fluctuations as a disequilibrium
  phenomenon
• Labor union truculence
• Wage legislation

2
Quarterly GDP, 1996 Dollars, Annual Rate
Recessions are shaded
www.economagic.com
3
Employment in Manufacturing Industries, Monthly,
in Thousands
Recessions are shaded
www.economagic.com
4
Housing Starts, Monthly, Annual Rate, in Thousands
Recessions are shaded
www.economagic.com
5
Monthly Consumer Durable Goods Sales, 1996
Dollars, Annual Rate
Recessions are shaded
www.economagic.com
6
Our next slide will illustratea recession that
results from a shift of the labor supply (LS)
schedule. Notice this is an equilibrium situation
in that both actual and potential GDP change.
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LS2
Real Wage
LS1
B
17
A
15
LD
0
Real GDP
Employment(millions)
100
92
7 Trillion
R
6.5 Trillion
Z
0
Employment(millions)
100
92
8
Some economists believe that fluctuations of real
GDP and employment can be explained by shifts in
the supply of laborbut they are in the minority.
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Our next slide will illustratea recession that
results from a shift of the labor supply (LD)
schedule. Again notice this is an equilibrium
situation in that both actual and potential GDP
change.
10
LS2
Real Wage
LS1
A
15
13
B
LD1
LD2
0
Real GDP
Employment(millions)
100
92
7 Trillion
R
6.5 Trillion
Z
0
Employment(millions)
100
92
11
Economists of the 1930s viewed the Depression as
a non-market clearing, disequilibrium
phenomenon. That is, frictions in the labor
market were causing the wage to get stuck above
its equilibrium value.
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Real Wage
Excess Supply
LS1
Wage is stuck at 17
17
A
15
LS
0
Real GDP
Employment(millions)
100
92
108
7 Trillion
R
Now we Have a GDP Gap .5 Trillion
6.5 Trillion
100
0
Employment(millions)
92
13
Why does the labor market fail to clear?

• Firms may have to pay minimum starting wages and
  benefits under the terms of collective bargaining
  agreements with the UAW, Teamsters, UMW, USW,
  UTW, or other major unions.
• Federal law stipulates minimum wages and
  contributions for social insurance.