aggregate demand, aggregate supply, and modern macroeconomics

© 2003 McGraw-Hill Ryerson Limited.

Aggregate Demand, Aggregate Demand, Aggregate Supply, Aggregate Supply,

and Modern and Modern MacroeconomicsMacroeconomics

Chapter 9Chapter 9

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IntroductionIntroduction Markets unleash individual initiative,

increase supply, and bring about growth.

But markets create recessions too.

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IntroductionIntroduction Macro intervention tools – monetary and

fiscal policy – are tools governments use on the aggregate demand side of the economy to deal with recessions, inflation, and unemployment.

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Introduction Introduction Since politicians make policy, it is

unlikely that they would do nothing in the face of a recession even if all economists agreed it was the right thing to do.

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The Historical The Historical Development of Development of Modern Modern Macroeconomics Macroeconomics The Great Depression of the 1930s was

a defining event in society's view of markets, and in the thinking about government macro policy.

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The Historical The Historical Development of Development of Modern Modern Macroeconomics Macroeconomics During the Depression, output fell by 30

percent and unemployment rose to nearly 20 percent. People wanted to work but could not find jobs at any wage.

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The Historical The Historical Development of Development of Modern Modern Macroeconomics Macroeconomics Before the Depression, the prominent

ideology was laissez-faire - keep the government out of the economy.

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The Historical The Historical Development of Development of Modern Modern Macroeconomics Macroeconomics After the Depression, most people

believed government should have a role in regulating the economy.

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From Classical to From Classical to Keynesian EconomicsKeynesian Economics Pre-Depression economists focused on

long-run issues such as growth. They were called Classical economists.

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From Classical to From Classical to Keynesian Economics Keynesian Economics Depression-era economists began to

focus on short-run economic issues, especially the issue of how to dig out of the Depression.

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From Classical to From Classical to Keynesian Economics Keynesian Economics They were called Keynesians after

economist John Maynard Keynes, author of The General Theory of Employment, Interest and Money, and the founder of modern macroeconomics.

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Classical EconomicsClassical Economics The Classical economists' approach

was laissez-faire (leave the market alone).

They felt the market was self-adjusting, and they also concentrated on the long-run and largely ignored the short-run.

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Classical EconomicsClassical Economics When the Great Depression hit with

high unemployment, their response was to refer to supply and demand in the labour market.

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Classical EconomicsClassical Economics Their solution to the high unemployment

was to eliminate labour unions and government policies that kept wages too high.

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The Layperson's The Layperson's Explanation for Explanation for UnemploymentUnemployment The layperson's explanation for

unemployment was different. They were not pleased with the

classical argument but believed instead that the Depression was caused by an oversupply of goods that glutted the market.

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The Layperson's The Layperson's Explanation for Explanation for UnemploymentUnemployment Lay people advocated hiring people

even if the work was not needed.

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The Layperson's The Layperson's Explanation for Explanation for UnemploymentUnemployment Classical economists opposed deficit

spending, arguing that the money to create jobs had to come from somewhere.

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The Layperson's The Layperson's Explanation for Explanation for UnemploymentUnemployment Government demands for capital would

crowd out private demands for money so the net effect would be zero, according to the Classical view.

Their advice was to have faith in the markets.

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The Essence of The Essence of Keynesian EconomicsKeynesian Economics The essence of Keynesian economics

is stabilization through government efforts.

As Keynes put it: “In the long run we are all dead”.

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The Essence of The Essence of Keynesian EconomicsKeynesian Economics By changing his focus, he created the

macroeconomic framework that emphasizes stabilization policy.

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The Essence of The Essence of Keynesian EconomicsKeynesian Economics Keynes thought that the economy could

be stuck in a rut as wages and price level adjusted to sudden changes in expenditures.

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The Essence of The Essence of Keynesian EconomicsKeynesian Economics The Keynesian linkage was:

decrease in investment demand job layoffs fall in consumer demand firms decrease production more job

layoffs further fall in consumer demand, and so forth

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The Essence of The Essence of Keynesian EconomicsKeynesian Economics Too little spending caused

unemployment. To break out of the rut, spending had to

increase.

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Equilibrium Income Equilibrium Income FluctuatesFluctuates Income is not fixed at the economy's

long-run potential income – it fluctuates. For Keynes there was a difference

between equilibrium income and potential income.

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Equilibrium Income Equilibrium Income FluctuatesFluctuates Equilibrium income – the level of

income toward which the economy gravitates in the short run because of the cumulative circles of declining or increasing production.

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Equilibrium Income Equilibrium Income FluctuatesFluctuates Potential income – the level of income

that the economy technically is capable of producing without generating accelerating inflation.

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Equilibrium Income Equilibrium Income FluctuatesFluctuates Keynes felt that at certain times the

economy needed help to reach its potential income.

Market forces would not work fast enough and not be strong enough to get the economy out of a recession

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Equilibrium Income Equilibrium Income FluctuatesFluctuates Because short-run aggregate

production decisions and expenditure decisions were interdependent, the downward spiral could start at any time.

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The Paradox of ThriftThe Paradox of Thrift The paradox of thrift is important to the

Keynesian story. According to the paradox of thrift, an

increase in savings can lead to a decrease in expenditures, decreasing output and causing a recession.

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The Paradox of ThriftThe Paradox of Thrift Saving can be seen as something good,

it leads to investments that leads to growth.

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The Paradox of ThriftThe Paradox of Thrift But if savings were not translated into

investment as happened during the Great Depression total spending would fall and unemployment would rise.

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The Paradox of ThriftThe Paradox of Thrift These concerns led to the development

of the aggregate demand/aggregate supply model.

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The Paradox of ThriftThe Paradox of Thrift It is this model that most economists

use to discuss short-term fluctuations in output and unemployment.

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The AS/AD ModelThe AS/AD Model The AS/AD model consists of three

curves: the short run aggregate supply curve (SRAS), the aggregate demand curve (AD), and the long run aggregate supply curve (LRAS).

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The AS/AD ModelThe AS/AD Model The short run aggregate supply

curve – the curve describing the supply side of the aggregate economy.

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The AS/AD ModelThe AS/AD Model The aggregate demand curve – the

curve describing the demand side of the aggregate economy.

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The AS/AD ModelThe AS/AD Model The long run supply curve – the curve

describing the highest sustainable level of output.

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The AS/AD ModelThe AS/AD Model The AS/AD model is fundamentally

different from the microeconomic supply/demand model.

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The AS/AD ModelThe AS/AD Model In the microeconomic supply/demand

model the price of a single good is on the vertical axis and the quantity of a single good on the horizontal axis.

The shapes are based on the concepts of substitution and opportunity cost.

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The AS/AD ModelThe AS/AD Model In the AS/AD model the price of all

goods,measured by the GDP deflator, is on the vertical axis and aggregate output is on the horizontal axis.

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The AS/AD ModelThe AS/AD Model The AS/AD model is an historical model

that starts at a point in time and says what will happen when changes affect the economy.

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The Aggregate Demand The Aggregate Demand CurveCurve The aggregate demand (AD) curve

shows how a change in the price level changes aggregate expenditures on all goods and services in an economy.

The AD curve is an equilibrium curve.

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The Slope of the AD The Slope of the AD CurveCurve The AD is a downward sloping curve. Aggregate demand is composed of the

sum of aggregate expenditures.

Expenditures = C + I + G +(X - IM)

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The Slope of the AD The Slope of the AD CurveCurve The slope of the curve depends on how

these components respond to changes in the price level.

A falling price level is assumed to increase aggregate expenditures, due to the Wealth effect Interest rate effect International effect

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The AD Curve, The AD Curve, Fig. 9-1, p 215Fig. 9-1, p 215

Pricelevel

Real output

Aggregate demand

P1

Y1

Wealth, interest rate, and international effects

Multiplier effect

Ye

P0

Y0

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The Wealth EffectThe Wealth Effect The wealth effect tells us that as the

price level falls, the value of cash rises so that those who hold money and other financial assets become richer, and buy more.

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The Wealth EffectThe Wealth Effect While economists accept the logic of the

argument, they do not see the wealth effect as strong.

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The Interest Rate EffectThe Interest Rate Effect The interest rate effect is the effect a

lower price level has on investment expenditures through the effect that a change in the price level has on interest rates.

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The Interest Rate EffectThe Interest Rate Effect The linkage is: a decrease in the price level increase

of real cash interest rates fall banks have more money to lend

investment expenditures increase jobs are created consumer

expenditures increase

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The International EffectThe International Effect The international effect tells us that as

the price level falls (assuming the exchange rate does not change), net exports will rise.

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The International EffectThe International Effect The linkage is:a decrease in the price level in Canada

the fall in price of Canadian goods relative to foreign goods Canadian

goods become more competitive internationally Canadian exports rise

and imports fall.

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The Multiplier EffectThe Multiplier Effect A change in quantity demanded has

repercussions on production (supply decisions) and subsequently on income and expenditures (demand decisions).

These repercussions are called multiplier effects.

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The Multiplier EffectThe Multiplier Effect As the price level falls, the initial

changes due to the wealth, interest rate, and international effects set in motion a process in the economy that amplifies the initial effects.

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The Multiplier EffectThe Multiplier Effect The multiplier effect is the

amplification of initial changes in expenditures.

The multiplier effect makes the aggregate demand curve flatter.

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Shifts in the AD CurveShifts in the AD Curve Except for a change in the price level,

anything that changes aggregate expenditures shifts the AD curve.

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Shifts in the AD CurveShifts in the AD Curve The main shift factors of aggregate

demand are foreign income, expectations about future output or

prices, exchange rate fluctuations, the distribution of income, and monetary and fiscal policies.

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Foreign IncomeForeign Income When Canada’s trading partners go into

a recession, the demand for Canadian goods (exports) will fall, causing the Canadian AD curve to shift to the left.

A rise in foreign income leads to an increase in Canadian exports and a rightward shift of the Canadian AD curve.

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Exchange RatesExchange Rates When a currency loses value relative to

other currencies, export goods produced in that country become less expensive and imports into that country become more expensive.

9 - 59


Exchange RatesExchange Rates Foreign demand for its goods increases

and its demand for foreign goods decreases as individuals do their spending at home.

The AD curve will shift to the right. When a currency gains value, the AD

curve shifts to the left.

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Expectations About Expectations About Future Output Future Output If businesses expect demand to be high

in the future, they will want to increase their capacity to produce.

Their demand for investment, a component of aggregate equilibrium demand will increase as well.

The AD curve will shift to the right.

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Expectations About Expectations About Future Output Future Output When consumers expect the economy

to do well in the future, they will spend more now.

The AD curve shifts to the right.

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Expectations of Future Expectations of Future PricesPrices If one expects the prices of goods to

rise in the future while the current price remains constant, it pays to buy goods now before the prices rise.

The AD curve will shift to the right. This is most acutely felt in a

hyperinflation.

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Expectations of Future Expectations of Future PricesPrices It is difficult to specify the exact reason

why expectations will cause a shift in the AD curve because of the interrelatedness of various types of expectations.

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Distribution of IncomeDistribution of Income People tend to spend a greater

percentage of their wage income as compared to their profit income.

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Distribution of IncomeDistribution of Income As real wages increase, while total

income remains constant, it is likely that the AD curve will shift to the right.

As real wages decrease, it is likely that the AD curve will shift to the left.

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Monetary and Fiscal Monetary and Fiscal PolicyPolicy Activist macro policy makers think they

can control the AD curve to some extent.

Macro policy is the deliberate shifting of the AD curve to influence the level of income in the economy.

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Monetary and Fiscal Monetary and Fiscal PolicyPolicy If the federal government spends lots of

money or lowers taxes, it shifts the AD curve to the right.

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Monetary and Fiscal Monetary and Fiscal PolicyPolicy When the Bank of Canada expands the

money supply, it can often lower interest rates and thereby shift the AD curve to the right.

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Monetary and Fiscal Monetary and Fiscal PolicyPolicy Expansionary macro policy shifts the

AD curve to the right. Contractionary macro policy shifts it to

the left.

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Multiplier Effects of Multiplier Effects of Shift FactorsShift Factors An AD curve cannot be treated like a

micro demand curve. When a shift factor of the AD curve

causes it to move, it moves by more than the initial shift factor because of the multiplier effect.

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Effect of a Shift Factor Effect of a Shift Factor on the AD Curve, on the AD Curve, Fig. 9-2, p Fig. 9-2, p 219219

Price level

Real output

AD0

P0

Initial effect

100

Change in total expenditures

300

AD1

Multipliereffect 200

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The Aggregate Supply The Aggregate Supply CurveCurve The Short run aggregate supply

(SAS) curve shows how firms adjust the quantity of real output they will supply when the price level changes, holding all input prices fixed.

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The Slope of the SAS The Slope of the SAS CurveCurve The SAS curve is an upward sloping

line because:Firms adjust both price and quantity in response to changes in aggregate demand.Differences between expected and actual price causes firms to i) adjust output believing there was a relative price change; ii) adjust quantity when it is costly to change price; and iii) change employment and production when real wages is not as expected.

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Shifts in the SAS CurveShifts in the SAS Curve Firms change their quantity and pricing

decisions when aggregate demand changes as well as in response to changes in their cost of production.

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Shifts in the SAS CurveShifts in the SAS Curve Costs of production include wage rates,

interest rates, energy prices, and change in prices of other factors of production.

SAS will shift in response to the change in productivity, as well as change in costs of production.

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Shifts in the SAS CurveShifts in the SAS Curve The net effect on prices :

% change in the price level = % change in wages – % change in

productivity

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Shifts in the SAS CurveShifts in the SAS Curve An increase in factor prices increases

the costs of production and shifts the SAS curve leftward.

A decline shifts it to the right.

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Shifts in the SAS CurveShifts in the SAS Curve An increase in productivity reduces the

cost of production and shifts the SAS curve to the right.

A decrease shifts it to the left.

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The Short Run The Short Run Aggregate Supply, Aggregate Supply, Fig. 9-3a Fig. 9-3a and b, p 220and b, p 220

P0

P1

SAS0

SAS1

Wage ratesrise

Real output

Price

leve

l

9 - 80


The Long Run The Long Run Aggregate Supply Aggregate Supply CurveCurve The final curve that makes up the

AD/AS model is the long run supply curve.

The long run supply curve shows the amount of goods and services an economy can produce when both labour and capital are fully employed.

9 - 81


The Long Run The Long Run Aggregate Supply Aggregate Supply CurveCurve LRAS is vertical since at potential

output, a rise in the price level means that all prices, including input prices rise.

Available resources do not rise, thus, neither does the potential output.

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The Long Run The Long Run Aggregate Supply Aggregate Supply Curve, Curve, Fig. 9-4, p 222Fig. 9-4, p 222

Potential output

Pric

e le

vel

Real output

LRAS

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Equilibrium in the Equilibrium in the Aggregate EconomyAggregate Economy Changes in the aggregate supply,

aggregate demand, and potential output curves affect short-run and long-run equilibrium.

9 - 84


Short-Run EquilibriumShort-Run Equilibrium Short-run equilibrium is where the SAS

and AD curves intersect. Shifts in either AD or SAS will affect

price levels and output. If AD increases (decreases), so do output

and prices. If SAS increases (decreases), output will

also increase (decrease), while price levels move in the opposite direction.

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Short-Run Equilibrium:Short-Run Equilibrium:Shift in Aggregate Shift in Aggregate Demand, Demand, Fig. 9-5a, p 222Fig. 9-5a, p 222

Y0

AD1

Real output

Price level

E

AD0

SAS

P0

Y1

FP1

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Short-Run Equilibrium:Short-Run Equilibrium:Shift in Short-run Shift in Short-run Aggregate SupplyAggregate Supply, , Fig. 9-5b, p Fig. 9-5b, p 222222

E

Real outputReal output

Price level

SAS1

Y0

SAS0

P0

AD0

G

Y2

P2

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Long-Run EquilibriumLong-Run Equilibrium Long-run equilibrium is determined by

the intersection of the AD curve and LRAS curve.

In the long run, output is fixed and the price level is variable.

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Long-Run EquilibriumLong-Run Equilibrium Aggregate demand determines the price

level. Increases (decreases) in aggregate

demand lead to higher (lower) prices.

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Long-Run Equilibrium, Long-Run Equilibrium, Fig. 9-6, p 225Fig. 9-6, p 225

LRAS

Real output

Price level

P0

Y0

E

HP1

AD1

AD0

9 - 90


Integrating the Short-Integrating the Short-Run and Long-Run Run and Long-Run FrameworksFrameworks When SAS and AD curves intersect at

the potential output, the economy is in both the long run and the short run equilibrium.

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Integrating the Short-Integrating the Short-Run and Long-Run Run and Long-Run FrameworksFrameworks The ideal situation is for aggregate

demand to grow at the same rate as aggregate supply and potential output.

Unemployment and growth will be at their target rates with no inflation.

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Short-Run and Long-Short-Run and Long-Run Equilibrium, Run Equilibrium, Fig. 9-7a, p Fig. 9-7a, p 225225

P0

Y

AD

LRAS

E

Real output

Price level

SAS

9 - 93


The Recessionary GapThe Recessionary Gap When the economy is in short-run

equilibrium but not in long-run equilibrium, and the output is below potential, there is a recessionary gap.

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The Recessionary GapThe Recessionary Gap A recessionary gap is the amount by

which equilibrium output is below potential output.

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The Recessionary GapThe Recessionary Gap If the economy remains at this level of

output for a long time, costs and wages would tend to fall because there would be an excess supply of factors of production.

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The Recessionary GapThe Recessionary Gap Factor prices will fall causing the SAS

curve to shift down to eliminate the recessionary gap.

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The Recessionary Gap, The Recessionary Gap, Fig. 9-7b, p 225Fig. 9-7b, p 225

A

Recessionary gap

Y0 Real output

Price level

LRAS

B

Y1

SAS1

SAS0

P0

P1

AD

9 - 98


The Inflationary GapThe Inflationary Gap The inflationary gap occurs when the

economy is above potential output that exists at the current price level.

If the economy is in a situation where short-run equilibrium is at a higher price level than the economy's potential output curve, we have inflation.

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The Inflationary GapThe Inflationary Gap Factor prices will rise causing the SAS

curve to shift up to eliminate the inflationary gap.

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(c)

The Inflationary Gap , The Inflationary Gap , Fig. Fig. 9-7c, p 2259-7c, p 225

Y0 Real output

Price level

LRAS

C

Y2

D

Inflationary gapAD

SAS0

SAS2

P2

P0

9 - 101


The Economy Beyond The Economy Beyond PotentialPotential How can the economy operate beyond

potential? It is possible to overutilize resources

beyond their potential for a brief time.

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The Economy Beyond The Economy Beyond PotentialPotential When a firm is below potential, firms

can hire additional factors of production to increase production without increasing production costs.

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The Economy Beyond The Economy Beyond PotentialPotential Once the economy reaches its potential

output that is no longer possible. If at that point, the firm wishes to increase

production, it must lure resources away from other firms.

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The Economy Beyond The Economy Beyond PotentialPotential As firms compete for resources, costs

rise beyond productivity increases. The SAS curve shifts up and the price

level rises.

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The Economy Beyond The Economy Beyond PotentialPotential At this point the economy will slow down

by itself or the government will step in with a policy to contract output and eliminate the inflationary gap.

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Some Additional Policy Some Additional Policy ExamplesExamples If politicians suddenly increase

government expenditures when the economy is well below potential output, output rises while the price level remains unchanged.

9 - 107


Some Additional Policy Some Additional Policy ExamplesExamples If consumer optimism leads to an

increase in expenditures when the economy is at the target rate of unemployment, the price level rises while output remains unchanged.

9 - 108


Shifting AD and SAS Shifting AD and SAS Curves, Curves, Fig 9-8a, p 228Fig 9-8a, p 228

Y0 Y1 Real output

Price level

A

LRAS

B

AD0

AD1

SAS90

9 - 109


Shifting AD and SAS Shifting AD and SAS Curves, Curves, Fig 9-8b, p 228Fig 9-8b, p 228

Y0

LRAS

Real output

Price level

Y1

CD

E

AD0

AD1

SAS0

SAS1

9 - 110


Macro Policy Is More Macro Policy Is More Complicated Than It Complicated Than It LooksLooks The problem in the AS/AD model is that

we have no way of knowing the level of potential output.

As a result, it is difficult to predict whether the SAS curve will be shifting up or not when aggregate demand increases.

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Three Policy RangesThree Policy Ranges An economy has three policy ranges

where the effect of an expansion of AD on the price level will be different: The Keynesian range. The Classical range. The intermediate range.

9 - 112


Three Policy RangesThree Policy Ranges The Keynesian range – when the

economy is far from potential income, and there is little fear that an increase in aggregate demand will cause the SAS curve to shift up and cause inflationary pressure.

The SAS is horizontal in this range, because all firms are quantity-adjusters.

9 - 113


Three Policy RangesThree Policy Ranges In the Keynesian range an increase in

aggregate demand will increase income and have no effect on the price level.

The price/output path of the economy is horizontal so that prices are fixed.

9 - 114


Three Policy RangesThree Policy Ranges The Keynesian range corresponds to

the recessionary gap and it is because of this that Keynesian economics is sometimes called depression or recession economics.

9 - 115


Three Policy RangesThree Policy Ranges The Classical range –the economy is

above the level of potential output so that any increase in aggregate demand will increase factor prices.

The SAS curve is pushed up by the full amount of the aggregate demand increase.

9 - 116


Three Policy RangesThree Policy Ranges In the Classical range, an increase in

aggregate demand will push up the price level and not affect real output.

The price/output path is vertical so that prices are flexible.

9 - 117


Three Policy RangesThree Policy Ranges The Classical range corresponds to the

inflationary gap.

9 - 118


Three Policy RangesThree Policy Ranges The intermediate range – when the

economy is between the two ranges, the AS curve will shift up some and real output will increase some.

The ratio between the two increases is determined by how close the economy is to its potential income.

9 - 119


Three Policy RangesThree Policy Ranges In the intermediate range, the

price/output path of the economy is upward sloping.

The economy is usually in this range.

9 - 120


Three Ranges of the Three Ranges of the Economy, Economy, Fig. 9-9, p 229Fig. 9-9, p 229

High potential

Keynesian range

Price level fixed

Low potential

Price/output path

Real output

Pric

e le

vel

Price level partially flexible

Intermediate range

Classical range

Price level very flexible

9 - 121


The Problem of The Problem of Estimating Potential Estimating Potential OutputOutput A key to policy is determining which

range we are in which requires us to determine the level of potential output.

Estimating potential output is difficult.

9 - 122


The Problem of The Problem of Estimating Potential Estimating Potential OutputOutput One way of estimating potential output

is to estimate the rate of unemployment below which inflation has begun to accelerate in the past.

This is called the target rate of unemployment.

9 - 123


The Problem of The Problem of Estimating Potential Estimating Potential OutputOutput One can then calculate output at the

target rate of unemployment, adjust for productivity growth, and estimate potential output.

9 - 124


The Problem of The Problem of Estimating Potential Estimating Potential OutputOutput Unfortunately, the target rate of

unemployment fluctuates and is difficult to predict.

For example, we don't know if we are dealing with structural or cyclical unemployment.

9 - 125


The Problem of The Problem of Estimating Potential Estimating Potential OutputOutput Another way gives us a very rough

estimate of potential output. The secular trend rate of growth is added to

the economy's previous income level.

9 - 126


The Problem of The Problem of Estimating Potential Estimating Potential OutputOutput Estimating potential income from past

growth rates can by questionable if such shift factors as regulations, technology, expectations, etc. are changing quickly or dramatically.

9 - 127


Some Real-World Some Real-World ExamplesExamples Canada in the mid-1990s:

Unemployment was 9 percent—high by normal standards—while inflation was 2 percent.

9 - 128


Some Real-World Some Real-World ExamplesExamples Canada in the mid-1990s:

Economist felt that the output was in the intermediate range (close to, or at, its potential).

If the economy expanded, the result would be inflation, not strong growth.

9 - 129


Some Real-World Some Real-World ExamplesExamples Japan in the late 1990s:

Unemployment was at 4.6 percent and inflation was at 1 percent.

The majority of economists believed that the economy had room for expansion and was far below potential compared to other industrial countries.

9 - 130


Some Real-World Some Real-World ExamplesExamples The European Union in the mid-1990s:

Unemployment was above 10 percent leading economists to think the EU was in the Keynesian range.

The EU was undergoing a restructuring of its economy.

9 - 131


Some Real-World Some Real-World ExamplesExamples The European Union in the mid-1990s:

Social programs significantly reduced people's incentive to work.

Economic theory could not explain what range the EU was actually in.

9 - 132


Some Real-World Some Real-World ExamplesExamples The United States in the mid-1990s:

The economy was expanding slowly albeit accompanied with major structural changes.

As firms expanded, they often laid off workers simultaneously.

These structurally unemployed workers needed retraining which needed time.

9 - 133


Some Real-World Some Real-World ExamplesExamples The United States in the mid-1990s:

Economists maintained that unemployment below 6.5 percent would generate inflation.

The unemployment rate fell to 5 percent – no inflation

Then to almost 4 percent – still no inflation.

9 - 134


Some Real-World Some Real-World ExamplesExamples

Output has fallen by 40 to 50 percent. As they struggle to create new

institutional structures, past data are meaningless.

Structural change in these countries is especially critical.

9 - 135


Debates About Debates About Potential OutputPotential Output Knowing potential output is crucial in

knowing what policy to advocate. According to real business cycle

economists, the best estimate of potential output is the actual income in the economy.

9 - 136


Debates About Debates About Potential OutputPotential Output Their Classical supply-side explanation

is called real business cycle theory.

All changes in the economy result from real shifts—shifts in potential output—that reflect real causes such as technological changes or shifting tastes.


End of Chapter 9End of Chapter 9

Aggregate Demand, Aggregate Demand, Aggregate Supply, Aggregate Supply,

and Modern and Modern MacroeconomicsMacroeconomics

aggregate demand, aggregate supply, and modern macroeconomics

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