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Macro Failures Let QF be the goal of

full-employment GDP. The equilibrium

output QE isundesirable; it doesnot reach our macrogoal.

Also, AD and AS canshift, meaning that anyequilibrium can beunstable.

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AS Shifts AS will shift left if

Business costs rise. Business taxes rise. Natural disaster occurs.

AS will shift right if Business costs fall. Business taxes fall. Bounteous harvests occur.

On the graph, AS shiftsleft away from full-employment GDP.

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AD Shifts AD will shift left if

Sending decreases. Expectations get worse.

Taxes increase. AD will shift right if

Spending increases. Expectations improve. Taxes decrease.

On the graph, AD shifts leftaway from full-employment GDP.

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Short-Run Instability:

Competing Theories Classical economists believe the economy will

self-regulate and gravitate toward full

employment. Keynes and his followers do not believe this.They believe the economy might get worsewithout government intervention.

In addition, there are controversies about theshape of AS and AD and the potential to shiftthese curves.

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Keynesian Theory This is a demand-side theory. A recession originates with a deficiency of

spending. AD is too far to the left. Policy: increase government spending to shift AD

back to the right.

Inflation originates with an excess in spending. AD is too far to the right. Policy: increase taxes to shift AD back to the left.

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Monetary Theory This is also a demand-side theory.

Emphasizes the role of money in financing AD. Tight money might cause AD to shift too far

to the left. Policy: increase money supply and lower interest

rates to shift AD back to the right. Easy money might cause AD to shift too far to

the right. Policy: decrease money supply and raise interest

rates to shift AD back to the left.

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Demand-Side Theories

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Supply-Side Theory A shift in AS to the left causes output and

employment to decrease and inflation to

increase. This problem cannot be corrected by shifting AD.

Shift AD right and unemployment falls but inflationworsens.

Shift AD left and inflation is reduced but unemploymentrises. Policy: devise ways to shift AS back to the right.

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Long-Run Self-Adjustment Advocates argue that short-run instability is

not as important as the long-run trend in

economic growth. Relies on the view that the economy can self-adjust. Once it adjusts to a short-run deviation, the

economy will return to its long-run growth path. There is a natural rate of output determined

by institutional factors.

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Short- and Long-Run Perspectives We live in the short run.

Short-run variations affect our current economicsituation.

We call on government to fix short -run problems now! Implemented policies take effect in the short-run. In the short run, AS slopes upward.

The macro model we will use to describe policyimplementation will have an upward-slopingAS curve.