Short Run Theory Explained

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Macro-Economics
MBA 520

Read the September 27, 2012 Washington Post article “Why a bull run for business investment may be over” by Neil Irwin (http”//www.washingtonpost.com/business/economy). Use the SR theory of the business cycle to explain Irwin’s premise and conclusions about the direction of the US macro economy. Be certain your narrative includes a. a description of the SR theory, (20 pts)

b. an analysis of how the level of investment spending is determined, why it has changed in the last four years, how it contributed to the recovery to date and may contribute in the next year and (50 pts)

The article “why a bull run for business investment may be over” is about how businesses aren’t investing enough or as much as they use to. It appears businesses are not investing enough due to the economic expansion which began in mid 2009. Even though business spending increased from 2010 to 2011, “the rate of growth in such spending has fallen in each of the past three quarters, and it rose at only a 4.8 percent annual rate in the April-June period”. Consumer spending, government spending and housing also went down because of the expansion. Based on this information I will be using the short run theory of the business cycle to explain Irwin’s premise and conclusions about the direction of the US macro economy then have a graphical explanation. The Short Run Theory model is used to determine real GDP. Our main concern is to minimize fluctuations in the unemployment and inflation rates; this requires that fluctuation in real GDP be minimized. Therefore full employment and external balance are required to minimize the business cycle. Profitability depends upon the economic stability within which to make decisions or at a minimum, the ability to track economic development that has an impact on profits. This theory involves ex post data, which is considered after the fact data. Output is equal to expenditures or GDP; where GDP is equal to the sum of consumption, investment, government spending on goods and services, and net exports (GDP = C+I+G+NX). The short run theory behavior has irregular recurrent expansions and contractions in output; this is where real GDP is equal to output. It also has the time period in which the general price level (P) is fixed, assuming that (P) stays the same, the price level stays relatively constant or fixed. There is variation in general level of output; this always happens before change in the general level of prices. In many instances prices are set by contracts that specify quantity and price. This may be due to the contractual nature of prices, since this tends to make prices sticky in the short run. There may be lack of knowledge or degree of uncertainty in decision making, menu costs hypothesis where businesses stick with costs in short run to avoid reprinting menu as well as it assumes we are not fully using our resource base. Short run can affect increase in demand by increasing production. In the short run, businesses behave as though the price level is fixed and the only way to adjust revenue is by adjusting output. You can sustain this in the short run, but not indefinitely. If you are not selling you will need to cut back on production, since change is spending decisions changes real GDP. You can also increase production when there is an increase in demand. The short run model is used to determine real GDP, since short run equilibrium defines ye; where the change in aggregate demand (AD) will change prices but not output. To begin an analysis of how the level of investment spending is determined, I will list each factor in the article and expand on each. Based on my analysis, it appears business spending on equipment and software has increase from 8.9% in 2010 to 11% in 2011. The rate of growth, however, has dropped the past 3 quarters while there was a 4.8% annual rate increase in April-June. The durable goods orders increased at the fastest rate since the financial...
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