5 The Supply Side

0081-001.gif
Figure 5.2
The multiplier process with price changes
Incorporating price changes into the multiplier 
process makes the multiplier smaller in real
 terms. This process is illustrated in Figure 5.1.
The three zones of the AS curve give rise to three different reactions to a dose of fiscal policy. When the AS curve is flat, the economy reacts primarily by increasing output; in the intermediate range both output and prices increase; and when the AS curve is vertical only price increases follow expansionary fiscal policy. The lesson should be clear. Expansionary policy is appropriate when the economy is in a severe recession, but is inappropriate in a boom.
5.4
Where Is Full Employment?
The analysis of the preceding section is antiquated and misleading, mainly because it contains a very naive view of what is happening in the labor market. In particular, there is no indication in figure 5.1 of the output level that would be generated by an economy at its natural rate of unemployment (NRU), which economists call full employment. Let us remedy this lack by drawing in figure 5.3 a vertical line at the level of output YNRU that the economy would produce if it were at its natural rate of unemployment. This line is labeled LRAS because, as will be seen shortly, it represents the aggregate supply curve of the economy in the long run when contractual and informational barriers to adjustment no longer exist. The up-ward-sloping line SRAS, akin to the intermediate section of the AS curve in the preceding section, is the short-run aggregate supply curve. For convenience the AD curve is drawn to pass through point A, the intersection of LRAS and SRAS.
Placing the full-employment position on this diagram allows a more realistic portrayal of an economy's reaction to a spending shock. Two such shocks are of interest: (1) an increase in aggregate demand for goods and services pushing the economy into a boom, and (2) a decrease in aggregate demand for goods and services pushing the economy into recession.

 



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

flylib.com © 2008-2017.
If you may any questions please contact us: flylib@qtcs.net