Friday, 12 October 2018: 3:40 PM
The main objective of the lecture is to use Hubbard’s description of the model of aggregate demand and aggregate supply to analyze economic fluctuations and stabilization policies under two methods: a static approach and a dynamic approach. After briefly deriving the aggregate demand and aggregate supply curves, I use the standard static approach to understand how real gross domestic product (GDP) and the price level are determined and how the economy self-adjusts to its natural rate of real GDP in the long run following a demand or supply shock. Because this self-adjustment process is slow and lengthy, I show that government stabilization policies are typically required. In the static case, it is assumed that there is no population growth, no economic growth, no expected inflation. With a vertical long-run aggregate supply curve and upward sloping short-run aggregate supply curve, when the economy experiences a negative demand shock, for example, the price level falls and real GDP falls below its natural level. Over time, expectations about the price level adjust and the economy slowly returns to its natural rate. To speed up the process of reaching the natural rate of real GDP, the government uses expansionary policies to stabilize output. This static approach appears to be too simple, however. The lecture also considers an analysis of aggregate demand and aggregate supply that accounts for dynamic changes in real GDP and the price level. This “dynamic” aggregate demand-aggregate supply model provides a more accurate understanding of the causes and consequences of fluctuations in real GDP and the price level. This model assumes that population growth causes aggregate demand to constantly increase, economic growth causes both aggregate supply curves to increase, and inflationary expectations cause the short-run aggregate supply curve to decrease. Under this scenario, the outcomes of a negative demand shock would be quite different.