In Macro-Economics we deal with the market for goods as a whole, treating all the markets for different goods-such as the markets for agricultural products and for medical services as a single market. Similarly, we deal with the labour-market as a whole, abstracting from differences between the markets, for, say unskilled labor and doctors. We deal with the assets market as a whole, abstracting from differences between the markets for IBM shares and for Rembrandt paintings.
The study of macroeconomics is organized around three models that describe the world, each model having its greatest applicability in a different time frame.Growth theory describes the behavior of the economy in the long run, when capital, labour and technology can all vary, and the AS-AD model describes the behavior of vthe economy at all shorter horizons, with different assumptions about the slope of the aggregate supply curve determining the time horizon over which the model is applicable.
The AS-AD model shows how the demand for products(described by the AD curve)interacts with the supply of products(described by the AS curve)to determine the equilibrium price level and output of the economy.
In the long run, because all inputs are fully employed, the AS curve is vertical at the level of potential output, and output is determined by AS alone. In the short run, a period of time so brief that prices do not have time to adjust at all, the AS curve is flat and output is determined by AD alone.
- The AS-AD model is used to show the determination of the equilibrium levels of both output and prices.
- The AS schedule, shows at each level of prices the quantity of real output firms are willing to supply.
- The Keynesian supply schedule is horizontal, implying that firms supply as many goods as are demanded at the existing price level. The classical supply schedule is vertical. It would apply in an economy that has full price and wage flexibility. In such a frictionless economy, employment and output are always at the full-employment level.
- The AD, shows at each price level the level of output at which goods and asset markets are in equilibrium. This is the quantity of output demanded at each price level.Along the AD schedule fiscal policy is given, as is the nominal quantity of money.
- A fiscal expansion shifts the Ad curve up and to the right, as does an increase in money stock , by the same proportion as an increase in the money stock.
- Supply side economics makes the claim that reducing tax rates generates very large increases in AS. In truth, tax cuts produce very small increases in AS and relatively large increases in AD.
- Over long periods, output is essentially determined by AS and prices by movement of AD relative to the movement of AS.