Download Chapter 15 - AP Macroeconomics

15
Modern Macroeconomics:
From the Short-Run to the Long-Run
LINKING THE SHORT RUN AND THE LONG RUN
The Difference Between the Short and Long Run
• short run in macroeconomics
The period of time in which prices do
not change or do not change very
much.
• long run in macroeconomics
The period of time in which prices have
fully adjusted to any economic changes.
Should economic policy be guided by what is expected to happen in the short
run, as Keynes thought, or what is expected to happen in the long run, as
Friedman thought? To answer this question, we need to know two things:
1 How does what happens in the short run determine what happens in the
long run?
2 How long is the short run?
LINKING THE SHORT RUN AND THE LONG RUN
Wages and Prices and Their Adjustment over Time
• wage–price spiral
The process by which changes in wages
and prices cause further changes in
wages and prices.
HOW WAGE AND PRICE CHANGES MOVE THE
ECONOMY NATURALLY BACK TO FULL EMPLOYMENT
Using aggregate demand and aggregate supply, we can illustrate graphically
how changing prices and wages help move the economy from the short to the
long run.
1 Aggregate demand.
• aggregate demand curve
A curve that shows the relationship between the level of prices and the
quantity of real GDP demanded.
2 Aggregate supply.
• short-run aggregate supply curve
A relatively flat aggregate supply curve that represents the idea that prices
do not change very much in the short run and that firms adjust production
to meet demand.
• long-run aggregate supply curve
A vertical aggregate supply curve that reflects the idea that in the long run,
output is determined solely by the factors of production.
HOW WAGE AND PRICE CHANGES MOVE THE
ECONOMY NATURALLY BACK TO FULL EMPLOYMENT
Returning to Full Employment from a Recession
How the Economy Recovers from a Downturn WITHOUT Intervention
UNDERSTANDING THE ECONOMICS
OF THE ADJUSTMENT PROCESS
How the Changing Price Level Restores the Economy to Full Employment
Why changes in wages and prices restore the economy to full employment:
(1) Changes in wages and prices change the demand for money.
(2) This changes interest rates, which then affect aggregate demand for goods
and services and ultimately GDP.
HOW WAGE AND PRICE CHANGES MOVE THE ECONOMY
NATURALLY BACK TO FULL EMPLOYMENT
Returning to Full Employment from a Boom
UNDERSTANDING THE ECONOMICS
OF THE ADJUSTMENT PROCESS
• political business cycle
The effects on the economy of using monetary or fiscal policy to
stimulate the economy before an election to improve reelection
prospects.
• liquidity trap
A situation in which nominal interest rates are so low, they can no
longer fall.
ECONOMICS OF THE ADJUSTMENT PROCESS
The Long-Run Neutrality of Money
• long-run neutrality of money
An increase in the supply of money has no effect on real interest rates,
investment, or output in the long run.
ECONOMICS OF THE ADJUSTMENT PROCESS
Crowding Out in the Long Run
• crowding out
The reduction in investment, or other component of GDP, in the long
run caused by an increase in government spending.
CLASSICAL ECONOMICS IN HISTORICAL
PERSPECTIVE
Say’s Law
Classical economics is often associated with Say’s law,
the doctrine that “supply creates its own demand.”
Keynes argued that there could be situations in which
total demand fell short of total production in the
economy—at least for extended periods of time.
Keynesian and Classical Debates
If wages and prices are not fully flexible, then Keynes’s
view that demand could fall short of production is more
likely to hold true. However, over longer periods of time,
wages and prices do adjust and the insights of the
classical model are restored.