Curiosity 5.1: How Do AD and AS Curves Differfrom Microeconomic Curves?

Curiosity 5.3: What Is Real Business Cycle Theory?
Another legacy of economists' revitalized interest in the supply side of the economy is real business cycle theory: the belief that real changes (as opposed to nominal changes that involve only changes in dollar values) such as technology shocks, new products, new government regulations (regarding such things as pollution), weather changes, changes in consumer preferences, natural resource discoveries, labor supply changes, tax rate changes, large changes in relative prices (such as that or oil), and other supply-side factors are primarily responsible for flucturations in economic activity. Also, according to this theory, traditional demand-side shocks play a secondary and very transitory role in affecting the economy. Real business cycle theory could be viewed as the most recent variant of supply-side economics because these real shocks primarily affect the supply curve rather than the demand curve. Although few economists feel that business cycles can adequately be explained by such supply-side phenomena alone, real business cycle theory has undoubtedly improved our understanding of business cycles by drawing economists' attention to the wide range of real phenomena that affect the economy and forcing them to think carefully about how they should be incorporated into an overall theory of how the macroeconomy operates.

Media Illustrations
Example 1
Michael Spence of Harvard University fears the high risks involved in some supply-side policies: "The Reagan people are currently arguing over what level of tax cuts should be implemented. What if they're wrong? What if the supply side doesn't respond enough to at least take care of the forgone revenues?"
Why can tax cuts be viewed as a supply-side policy?
Cutting tax rates causes people's after-tax return from working and investing to be greater, so there is greater incentive to work harder and invest more. This should increase aggregate supply.
What are the "forgone revenues"?
Forgone revenues are the reduction in tax revenues from the original income level due to the lower tax rate.
What is meant by the supply side responding by enough to take care of the forgone revenues?
The tax cut would need to cause a sufficiently large increase in income to make the rise in tax revenues due to higher income offset the fall in tax revenues due to the initiating tax cut.
What is the specific high risk that Spence is worried about here?
The risk that the tax cut will increase the budget deficit.

 



Macroeconomic Essentials. Understanding Economics in the News 2000
Macroeconomic Essentials - 2nd Edition: Understanding Economics in the News
ISBN: 0262611503
EAN: 2147483647
Year: 2004
Pages: 152

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