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Chapter 27 Notes - [ChapterTwentySeven TheAggregateDemand/...

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[Chapter Twenty Seven] The Aggregate Demand/Aggregate Supply Model Learning Objectives After reading the material in this chapter, you will be able to do the following: 1. Discuss the historical development of macroeconomics. 2. Explain the shape of the aggregate demand curve and what factors shift the curve. 3. Explain the shape of the short-run aggregate supply curve and what factors shift the curve. 4. Explain the shape of the long-run aggregate supply curve. 5. Show the effects of shifts of the aggregate demand and aggregate supply curves on the price level and output in both the short run and long run. 6. Explain how dynamic feedback effects can destabilize the economy. 7. Discuss the limitations of the macro policy model. Chapter Outline The Aggregate Demand/Aggregate Supply Model Markets can run into serious problems: recessions, inflation, and unemployment. In early 2008, economic growth in the U.S. was slowing even as inflation was picking up. By September 2008, the economy fell into a serious recession that many thought might lead to a depression. The tools government has to deal with recessions, unemployment, and inflation affect the aggregate demand side of the economy.
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Politicians make policy; they listen to economists only when they want to. The Historical Development of Macro An important reason for politicians’ initial interest in short-run demand policies is the Great Depression of the 1930s. Output fell by 30 percent and unemployment rose to 25 percent. From Classical to Keynesian Economics In the 1930s, macroeconomists started focusing their discussion of macroeconomic policy on short-run issues. The earlier economists who focused on long-run issues were called Classical economists; economists who focused on the short run were called Keynesian economists (so named because a leading advocate of this short-run focus was John Maynard Keynes). Classical Economists Classical economists believed in the market’s ability to be self- regulating through the invisible hand. As long as the economy was operating relatively smoothly, the Classical analysis of the aggregate economy met no serious opposition. Pushed to explain how the invisible hand could have allowed the Depression, Classical economists pointed to labor unions and government policies that they argued kept prices and wages from falling. The Layperson’s Explanation for Unemployment Laypeople developed other explanations. One popular one was that an oversupply of goods had glutted the market; all that was needed to eliminate unemployment was for government to hire the unemployed. Classical economists argued against this view, pointing out that the money to hire people would have to be borrowed, reducing future private economic activity.
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