In microeconomic analysis, economists rely heavily on supply and demand curves. They would never attempt to explain an economic phenomenon or offer policy advice without examining both the supply and the demand side of the market. In light of this fact, it is remarkable that the Keynesian view of the macroeconomy, which focused almost exclusively on the demand side, was accepted so completely by the profession. In retrospect, this exclusive focus was a grievous error for three main reasons:
1. When the large supply-side shocks of the early 1970s, such as OPEC-enforced increases in the price of oil, hit the economy, the Keynesian analysts were caught unprepared. Their economic models could not be employed to analyze the macroeconomic problems created by these shocks, and so they were not able to offer useful advice.
2. Without the supply side of the economy, economists could not produce convincing analyses of business cycles; nor could they explain anomalous facts such as simultaneous increases in inflation and unemployment.
3. Neglecting the supply side deflected economists' attention from economic growth and increasing living standards from what is happening to aggregate supply in the very long run. In the early 1970s, when the economy's growth rate slowed dramatically, they were inadequately prepared to analyze this phenomenon or prescribe policy to deal with it.
The purpose of this chapter is to discuss the supply side of the economy and how it can be integrated into macroeconomic analysis in the short and long runs. Discussion of the very long run, the topic of economic growth, is postponed until the next chapter.
