多恩布什《宏观经济学》第十版英文原版i05revised

CHAPTER5AGGREGATESUPPLYANDDEMANDCHAPTEROUTLINETHECLASSICALASCURVETHEKEYNESIANASCURVETHEPRICEADJUSTMENTMECHANISMFRICTIONALUNEMPLOYMENTTHEQUANTITYTHEORYOFMONEYTHEADASFRAMEWORKTHEEFFECTSOFSHIFTSINAGGREGATEDEMANDSUPPLYSIDEECONOMICSDYNAMICSCORINGLONGRUNSHIFTSINAGGREGATEDEMANDANDSUPPLYCHANGESFROMTHEPREVIOUSEDITIONANEWBOX52FORMERBOX62HASBEENINSERTEDTODISTINGUISHBETWEENTHEVERYSHORTRUNASCURVETHEHORIZONTALKEYNESIANASCURVEANDTHEUPWARDSLOPING,MEDIUMRUNASCURVEOLDBOX52HASBECOMENEWBOX53NEWSECTION52FORMERSECTION61,WHICHDESCRIBESTHEPRICEADJUSTMENTMECHANISM,ALSOHASBEENINSERTEDALLFOLLOWINGBOXESANDSECTIONSHAVEBEENRENUMBEREDINTRODUCTIONOFTHEMATERIALINTHISCHAPTER,THEADASMODELISPRESENTEDASABASICMACROECONOMICMODELFORDETERMININGTHEOUTPUTANDPRICELEVELSTHEASCURVEDESCRIBESTHEQUANTITYOFGOODSANDSERVICESFIRMSAREWILLINGTOSUPPLYATEACHPRICELEVELTHEADCURVESHOWSALLPOSSIBLECOMBINATIONSOFTHEPRICEANDOUTPUTLEVELATWHICHTHEGOODSANDMONEYSECTORSARESIMULTANEOUSLYINEQUILIBRIUMTWOSPECIALCASESAREEXAMINEDTHECLASSICALASCURVE,REPRESENTINGTHELONGRUN,ANDTHEKEYNESIANASCURVE,REPRESENTINGTHEVERYSHORTRUNTHECLASSICALASCURVEISVERTICAL,BASEDONTHEASSUMPTIONTHATLABORMARKETSWORKSMOOTHLYANDALWAYSMAINTAINANEQUILIBRIUMATFULLEMPLOYMENTHERE,ASHIFTINAGGREGATEDEMANDHASNOEFFECTONTHELEVELOFOUTPUTBUTDOESLEADTOACHANGEINTHEPRICELEVELTHEKEYNESIANASCURVEISHORIZONTAL,INDICATINGTHATFIRMSWILLSUPPLYWHATEVERAMOUNTOFGOODSISDEMANDEDATTHEEXISTINGPRICELEVELWAGESREMAINCONSTANT,ANDTHEREFOREACHANGEINAGGREGATEDEMANDCHANGESTHELEVELOFOUTPUT,WHILETHEPRICELEVELREMAINSUNAFFECTEDTHECLASSICALCASEIMPLIESTHATTHELABORMARKETISALWAYSINAFULLEMPLOYMENTEQUILIBRIUM,ALTHOUGHSOMEFRICTIONALUNEMPLOYMENTALWAYSEXISTSASPEOPLESWITCHJOBSTHEAMOUNTOFUNEMPLOYMENTTHATEXISTSATFULLEMPLOYMENTISCALLEDTHENATURALRATEOFUNEMPLOYMENTMANYECONOMISTSESTIMATETHISRATETOCURRENTLYTOBEATAROUND52PERCENTFORTHEUNITEDSTATES,BUTANEXACTVALUEHASNEVERBEENESTABLISHEDTHECORRESPONDINGFULLEMPLOYMENTLEVELOFOUTPUTISCALLEDPOTENTIALGDPWHILEPOTENTIALGDPCHANGESEVERYYEARDUETOTECHNOLOGICALIMPROVEMENTS,THECHANGESDONOTDEPENDONTHEPRICELEVELWHILEWECANDISTINGUISHBETWEENAHORIZONTALSHORTRUN,AVERTICALLONGRUN,ANDANUPWARDSLOPINGMEDIUMRUNASCURVE,ITISALSOPOSSIBLETOTHINKOFTHEASCURVEASROTATINGOVERTIMEFROMHORIZONTALTOVERTICALSIMILARLY,ITISPOSSIBLETOIMAGINEANONLINEARASCURVETHATISALMOSTHORIZONTALINADEEPRECESSIONANDALMOSTVERTICALATTHEFULLEMPLOYMENTLEVELOFOUTPUTSEEFIGURE1OFBOX53THISIMPLIESTHATDEMANDMANAGEMENTCANINCREASEOUTPUTWITHOUTMUCHEFFECTONTHEPRICELEVELINARECESSION,WHILEITWILLNOTSTIMULATETHEECONOMYMUCHANDINSTEADLEADTOLARGEPRICEINCREASESINPERIODSOFFULLEMPLOYMENTTHEADCURVESHOWSALLCOMBINATIONSOFTHEPRICELEVELANDOUTPUTATWHICHTHEGOODSANDMONEYSECTORSARESIMULTANEOUSLYINEQUILIBRIUMTHEADCURVESHIFTSTOTHERIGHTLEFTWHENEVEREXPANSIONARYRESTRICTIVEFISCALORMONETARYPOLICIESAREEMPLOYEDTHETEXTUSESTHEQUANTITYTHEORYOFMONEYASASIMPLEWAYTODERIVETHEADCURVEMOREDETAILSABOUTAGGREGATEDEMANDAREGIVENINLATERCHAPTERSTHEKEYTOUNDERSTANDINGTHEADCURVEISTOUNDERSTANDTHATACHANGEINNOMINALMONEYSUPPLYAPOLICYCHANGEWILLSHIFTTHEADCURVE,WHILEACHANGEINREALMONEYSUPPLYCAUSEDBYACHANGEINTHEPRICELEVELTHEPRICEADJUSTMENTISAMOVEMENTALONGTHEADCURVECHAPTER5ALSOBRIEFLYDISCUSSESSUPPLYSIDEECONOMICSMANYSUPPLYSIDERSHAVEARGUEDTHATITISIMPORTANTTOCONSIDERTHEPRINCIPLEOFDYNAMICSCORINGTHEIRARGUMENTISTHATACUTININCOMETAXRATESWILLINCREASEECONOMICGROWTH,ANDTHEREFOREANYINITIALINCREASEINTHEBUDGETDEFICITWILLBEATLEASTPARTIALLYOFFSETBYINCREASEDTAXCOLLECTIONSLATERONFIGURE511ISUSEDTOSHOWTHATACUTININCOMETAXESWILLSIMULTANEOUSLYSHIFTAGGREGATEDEMANDANDAGGREGATESUPPLYTOTHERIGHTWHILEMANYECONOMISTSFAVORSOMESUPPLYSIDEPOLICIES,FEWBELIEVETHATASIMPLEINCOMETAXCUTWILLACHIEVETHEDESIREDGOALOFINCREASEDOUTPUTCOMBINEDWITHALOWERPRICELEVELTHISISBECAUSEATAXCUTWILLSHIFTTHEADCURVESWIFTLYANDBYALARGEAMOUNT,BUTPOTENTIALGDPTHEVERTICALASCURVEWILLSHIFTONLYINTHELONGRUNANDBYAFAIRLYSMALLAMOUNTSINCETHEASCURVEISVERYFLATINTHEVERYSHORTRUN,WESHOULDFIRSTSEEARISEINGDPACCOMPANIEDBYNOORONLYSMALLINCREASESINTHEPRICELEVELBUTSINCETHELONGRUNASCURVEISVERTICAL,THEECONOMYWILLEVENTUALLYSETTLEATANEWLONGRUNEQUILIBRIUMWITHASMALLINCREASEINGDPANDAMUCHHIGHERPRICELEVELASPOTENTIALGDPGROWSOVERTIME,THEVERTICALLONGRUNASCURVECONTINUESTOSHIFTTOTHERIGHTTHEREFORE,THEPRICELEVELEACHYEARISDETERMINEDBYTHERELATIVESHIFTSOFTHEASCURVEANDTHEADCURVE,WHILETHELEVELOFOUTPUTISESSENTIALLYDETERMINEDBYTHEMOVEMENTOFTHEASCURVEALONESUGGESTIONSFORLECTURINGINTHISCHAPTERTHEEFFECTSOFCHANGESINAGGREGATEDEMANDONOUTPUTANDPRICESCANBEDISCUSSEDUSINGTHEADASFRAMEWORKBEFORETHISISDONE,HOWEVER,INSTRUCTORSNEEDTOPOINTOUTTHEDIFFERENCEBETWEENANORDINARYMARKETDEMANDANDSUPPLYMODELANDTHEAGGREGATEDEMANDANDSUPPLYMODELDISCUSSEDHERESEEBOX51INSTRUCTORSSHOULDALSOSPENDSOMETIMEDISTINGUISHINGBETWEENASHIFTINTHEADCURVECAUSEDBYAPOLICYCHANGEANDAMOVEMENTALONGTHEADCURVETHEPRICEADJUSTMENTTODOTHIS,INSTRUCTORSSHOULDFIRSTESTABLISHTHATTHEADCURVEDEPENDSONTHEAMOUNTOFREALMONEYBALANCESAVAILABLEINTHEECONOMYTHISCANEASILYBEDONEWITHTHEHELPOFTHEQUANTITYTHEORYOFMONEY,THATIS,EQUATION1,WHICHSTATESTHATMVPY,FROMWECANDERIVEADOWNWARDSLOPINGCURVEOFTHEFORMPMV/YIFWEASSUMETHATNOMINALMONEYSUPPLYMANDTHEINCOMEVELOCITYOFMONEYVARECONSTANT,THENTHISFUNCTIONISOFTHESAMEFORMASTHEFUNCTIONY1/X,THATIS,ADOWNWARDSLOPINGCURVEWITHADECREASINGSLOPESTUDENTSFAMILIARWITHMATHMAYNOTICETHATTHISFORMULAFORTHEADCURVEISTHEEQUATIONOFANONLINEARLINE,EVENTHOUGHTHEADCURVEINTHETEXTISDRAWNASALINEARLINEHOWEVER,DRAWINGBOTHTHEADANDASCURVESASLINEARMAKESTHEGRAPHICALANALYSISSOMEWHATEASIERWHENEXPLAININGTHEEFFECTSOFAPOLICYCHANGEONOUTPUTANDPRICES,INSTRUCTORSMAYPREFERTODRAWONLYPARALLELSHIFTSOFTHEADCURVE,EVENTHOUGHTHISMAYBEADEPARTUREFROMTHEACTUALMATHEMATICALDERIVATIONOFTHECURVEDRAWINGLINEARLINESANDPARALLELSHIFTSWILLSIMPLIFYTHINGSWITHOUTMUCHLOSSOFEXPLANATORYPOWERTHEKEYNESIANASCURVEASSUMESACONSTANTPRICELEVELINDEPENDENTOFTHELEVELOFGDPTHISISMOSTREALISTICOVERAPERIODOFAFEWMONTHSORLESSORDURINGPERIODSOFHIGHUNEMPLOYMENTHOWEVER,ALONGERTIMEFRAMEFORPOLICYANALYSISISMOREINTERESTINGINTHEMEDIUMRUN,THEASCURVEISASSUMEDTOBEUPWARDSLOPING,WHILEINTHELONGRUNTHEASCURVEISASSUMEDTOBEVERTICALBUTONECANALSOTHINKOFTHISASTHEASCURVESLOWLYROTATINGOVERTIMEFROMHORIZONTALTOVERTICAL,ASFIGURE56DEMONSTRATESTHEREISCONSIDERABLEDISAGREEMENTONHOWFASTPRICESADJUSTANDNOCLEARDEFINITIONOFTHELONGRUNINANYCASE,FORREASONSOFPOLITICALEXPEDIENCE,POLITICIANSTENDNOTTOWORRYTOOMUCHABOUTLONGRUNCONSEQUENCESWHENFACEDWITHSHORTRUNDISTURBANCESTHEREFORETHEUPWARDSLOPINGASCURVEISPROBABLYOFMOSTINTERESTBOX53EXPLAINSWHYITISASIMPLIFICATIONTOTHINKOFTHEASCURVEASEITHERHORIZONTALORVERTICAL,OREVENLINEARFORTHATMATTERFIGURE1INBOX53SHOWSANONLINEARASCURVEWITHAFAIRLYFLATPARTREPRESENTINGPERIODSOFDEEPRECESSIONSANDAFAIRLYSTEEPPARTREPRESENTINGPERIODSOFSTRONGBOOMSTHISFIGUREIMPLIESTHATANYEXPANSIONARYFISCALORMONETARYPOLICYTHATWILLLEADTOANINCREASEINAGGREGATEDEMANDWILLMOSTLYAFFECTTHELEVELOFOUTPUTWITHLITTLEUPWARDPRESSUREONTHEPRICELEVELINARECESSIONWHENTHEASCURVEISFAIRLYFLATBUTTHESAMEPOLICYMEASUREWILLLEADTOASUBSTANTIALPRICEINCREASEWITHFAIRLYLITTLEADDITIONALECONOMICSTIMULATIONINABOOMWHENTHEASCURVEISFAIRLYSTEEPITISIMPORTANTTOKEEPINMINDTHATTHEACTUALEFFECTOFANYPOLICYCHANGEONTHELEVELOFREALOUTPUTORTHEPRICELEVELDEPENDSPRIMARILYONTHESLOPEOFTHEASCURVETHETHEORYOFAGGREGATESUPPLYISDEVELOPEDINMOREDETAILINCHAPTER6HOWEVER,SOMEINSTRUCTORSMAYPREFERTOSPENDSOMETIMEHEREDISCUSSINGTHEREASONSFORANUPWARDSLOPINGASCURVE,SINCEMOSTMEANINGFULGRAPHICALEXAMPLESOFTHEEFFECTSOFPOLICYCHANGESAREBESTEXPLAINEDWITHSUCHANASCURVELATERCHAPTERSDISCUSSTHEDIFFERENTCATEGORIESOFAGGREGATEDEMANDINMOREDETAIL,BUTSTUDENTSCANBEASKEDTOTHINKOFAGGREGATEDEMANDASTHESUMOFFOURCATEGORIESOFSPENDING,THATIS,CIGNXTHEASSUMPTIONTHATNOMINALMONEYSUPPLYMDOESNOTCHANGEUNLESSTHEREISAMONETARYPOLICYCHANGEINITIATEDBYTHECENTRALBANK,HELPSTOEXPLAINWHYTHEADCURVEISDOWNWARDSLOPINGINTHISCASE,ANINCREASEINTHEPRICELEVELWILLDECREASEREALMONEYSUPPLYM/P,WHICHWILLAFFECTTHEQUANTITYOFTOTALOUTPUTDEMANDEDINTHEFOLLOWINGWAYSAHIGHERDOMESTICPRICELEVELPWILLLEADTOLESSREALMONEYBALANCESM/PANDTHEREFORELESSLIQUIDITYTHISWILLRESULTINHIGHERINTERESTRATESIANDTHUSALOWERLEVELOFINVESTMENTSPENDINGI,WHICHMEANSTHATTOTALOUTPUTDEMANDEDYWILLDECREASEAHIGHERDOMESTICPRICELEVELPWILLLEADTOLESSREALMONEYBALANCESM/PTHISWILLRESULTINLESSREALWEALTHANDTHEREFOREALOWERLEVELOFCONSUMPTIONC,WHICHMEANSTHATTOTALOUTPUTDEMANDEDYWILLDECREASEAHIGHERDOMESTICPRICELEVELPWILLMEANTHATDOMESTICGOODSWILLBECOMELESSCOMPETITIVEINWORLDMARKETSTHISWILLSTIMULATEIMPORTSWHILEREDUCINGEXPORTS,LEADINGTOAREDUCTIONINNETEXPORTSNX,WHICHMEANSTHATTOTALOUTPUTDEMANDEDYWILLDECREASESINCEGOVERNMENTPURCHASESGAREFIXEDINNOMINALTERMS,ANYINCREASEINTHEPRICELEVELPWILLDECREASETHEPURCHASINGPOWEROFTHEGOVERNMENTANDTHEREFORETHEMAGNITUDEOFGOVERNMENTPURCHASESINREALTERMS,LEADINGTOADECREASEINREALOUTPUTYDEMANDEDITISHELPFULTOPRESENTALLFOUROFTHESEEXPLANATIONSINCLASSHOWEVER,FORSIMPLICITY,INSTRUCTORSMAYUSEONLYTHEFIRSTOFTHESEFOUREXPLANATIONSINDESCRIBINGTHEPRICEADJUSTMENTPROCESSAFTERAPOLICYCHANGEORANYOTHERDISTURBANCEFROMTHISWECANSEETHATAPRICEADJUSTMENTISEQUIVALENTTOAMOVEMENTALONGTHEADCURVE,WHILEAMONETARYPOLICYCHANGEWILLSHIFTTHEWHOLEADCURVEANINCREASEINNOMINALMONEYSUPPLYMWILLLOWERINTERESTRATESANDINCREASETHELEVELOFINVESTMENTIORCONSUMPTIONCORNETEXPORTSNXINDEPENDENTOFTHEPRICELEVELTHISAMOUNTSTOASHIFTINTHEADCURVEHOWEVER,ANYDECREASEINREALMONEYBALANCESM/PDUETOACHANGEINTHEPRICELEVELPISAMOVEMENTALONGTHEADCURVE,ASDESCRIBEDBYTHEFOURADJUSTMENTPROCESSESABOVESEVERALDIFFERENTEXAMPLESOFPOLICYCHANGESTHATSHIFTTHEADCURVESHOULDBEGIVEN,DISCUSSINGTHEIREFFECTONOUTPUT,PRICES,ANDINTERESTRATESUNDERDIFFERENTASSUMPTIONSABOUTTHESLOPEOFTHEASCURVEHOWEVER,SHIFTSINTHEASCURVEALSODESERVESOMEATTENTIONASTHEDISCUSSIONOFSUPPLYSIDEECONOMICSINSECTION55POINTSOUT,IMPORTANTLONGRUNGAINSINLIVINGSTANDARDSMAYBEACHIEVEDIFITISINDEEDPOSSIBLETOINCREASEPOTENTIALGDPTHROUGHAPPROPRIATEGOVERNMENTPOLICIESSTUDENTSMAYBEATLEASTSOMEWHATFAMILIARWITHTHESUPPLYSIDEEXPERIMENTUNDERPRESIDENTREAGANINTHEEARLY1980S,SOSECTION55MAYSERVEASFERTILEGROUNDFORALIVELYCLASSROOMDISCUSSIONTHEFACTTHATMANYECONOMISTSDONOTLOOKFAVORABLYUPONTHEECONOMICPOLICIESOFTHEREAGANADMINISTRATIONDOESNOTNECESSARILYIMPLYTHATTHEYAREAGAINSTSUPPLYSIDEPOLICIESAFTERALL,DEMANDMANAGEMENTPOLICIESAREONLYUSEFULFORSHORTRUNECONOMICSTABILIZATION,WHILESUPPLYSIDEPOLICIESAREDESIGNEDTOPERMANENTLYINCREASENATIONALOUTPUTSTUDENTSSHOULDBEAWARETHATATAXCUTDESIGNEDTOSHIFTTHEASCURVETHERIGHTWILLPROBABLYHAVEAMOREIMMEDIATEEFFECTONAGGREGATEDEMANDTHEREFORE,THISPOLICYSPROMISEOFAHIGHEROUTPUTLEVELCOMBINEDWITHALOWERPRICELEVELISLIKELYTOREMAINUNFULFILLEDINTHEDISCUSSIONOFTHEEFFECTSOFINCOMETAXRATECUTS,THEPRINCIPLEOFDYNAMICSCORING,PRESENTEDINBOX55,SHOULDBEDISCUSSED,EVENTHOUGHECONOMISTSTENDTODISAGREEONITSPRACTICALAPPLICATIONFINALLY,SINCECHAPTERS3AND4DEALTWITHECONOMICGROWTHINTHELONGRUN,FIGURE512WARRANTSSOMEATTENTIONITSHOWSSHIFTSINTHELONGRUNASCURVE,REPRESENTINGGROWTHINPOTENTIALGDPOVERTIMEIFTHEADCURVEALSOSHIFTSOVERTIMEDUETOMONEYEXPANSION,THENOVERTHELONGRUNTHEPRICELEVELWILLBEDETERMINEDBYTHESHIFTINTHEADCURVERELATIVETOTHESHIFTINTHEASCURVEHOWEVER,THELEVELOFOUTPUTISESSENTIALLYDETERMINEDBYSHIFTSINTHELONGRUNASCURVEADDITIONALREADINGSBALL,LANDMANKIW,G,“THENAIRUINTHEORYANDPRACTICE,”JOURNALOFECONOMICPERSPECTIVES,FALL,2002BARRO,ROBERT,“THEAGGREGATESUPPLY/AGGREGATEDEMANDMODEL,”EASTERNECONOMICJOURNAL,WINTER,1994BOSKIN,MICHAEL,“TAXPOLICYANDECONOMICGROWTHLESSONSFROMTHE1980S,”JOURNALOFECONOMICPERSPECTIVES,FALL,1988FELDSTEIN,MARTIN,“SUPPLYSIDEECONOMICSOLDTRUTHANDNEWCLAIMS,”AMERICANECONOMICREVIEW,MARCH,1986ESPINOSAVEGA,MANDRUSSELL,S,“HISTORYANDTHEORYOFTHENAIRUACRITICALREVIEW,”ECONOMICREVIEW,FRBOFATLANTA,SECONDQUARTER,1997GALBRAITH,JAMES,“TIMETODITCHTHENAIRU,”JOURNALOFECONOMICPERSPECTIVES,WINTER,1997KATZ,LAWRENCE,“WHATWEKNOWANDDONOTKNOWABOUTTHENATURALRATEOFUNEMPLOYMENT,”JOURNALOFECONOMICPERSPECTIVES,WINTER,1997LUCAS,ROBERT,“MACROECONOMICPRIORITIES,”PRESIDENTIALADDRESSINAMERICANECONOMICREVIEW,PAPERSANDPROCEEDINGS,MAY,2003SOLOW,ROBERT,“TOWARDSAMACROECONOMICSOFTHEMEDIUMRUN,”JOURNALOFECONOMICPERSPECTIVES,WINTER,2000STIGLITZ,JOSEPH,“REFLECTIONSONTHENATURALRATEHYPOTHESIS,”JOURNALOFECONOMICPERSPECTIVES,WINTER,1997LEARNINGOBJECTIVESSTUDENTSSHOULDKNOWTHEDISTINCTIONBETWEENMARKETDEMANDANDSUPPLYVERSUSAGGREGATEDEMANDANDSUPPLYSTUDENTSSHOULDBEABLETODISTINGUISHBETWEENTHECLASSICALANDKEYNESIANASCURVESSTUDENTSSHOULDKNOWTHEQUANTITYTHEORYOFMONEYEQUATIONANDHOWITRELATESTOTHESHAPEOFTHEADCURVESTUDENTSSHOULDBEABLETOGRAPHICALLYDETERMINETHEEFFECTSOFSHIFTSINAGGREGATEDEMANDONTHEOUTPUTANDPRICELEVELINANADASFRAMEWORKSTUDENTSSHOULDBEABLETODESCRIBETHEADJUSTMENTPROCESSTHATTAKESPLACEASTHEECONOMYMOVESFROMONEMACROEQUILIBRIUMTOANOTHERSTUDENTSSHOULDUNDERSTANDWHATTHENATURALRATEOFUNEMPLOYMENTISSTUDENTSSHOULDBEABLETODISCUSSTHEMERITSOFTHECLAIMSOFSUPPLYSIDEECONOMISTSTHATINCOMETAXCUTSWILLLEADTOSUBSTANTIALGAINSINOUTPUTWHILELOWERINGINFLATIONSTUDENTSSHOULDBEFAMILIARWITHTHECONCEPTOFDYNAMICSCORINGSTUDENTSSHOULDKNOWTHAT,INTHELONGRUN,THELEVELOFOUTPUTISDETERMINEDBYSHIFTSINTHELONGRUNVERTICALASCURVE,WHILETHEPRICELEVELISDETERMINEDBYTHERELATIVESHIFTSOFTHEASCURVEANDTHEADCURVESOLUTIONSTOTHEPROBLEMSINTHETEXTBOOKCONCEPTUALPROBLEMS1THEAGGREGATESUPPLYCURVESHOWSTHEQUANTITYOFTOTALOUTPUTTHATFIRMSAREWILLINGTOSUPPLYATEACHPRICELEVELTHEAGGREGATEDEMANDCURVESHOWSTOTALOUTPUTDEMANDEDITDEPICTSALLCOMBINATIONSOFREALTOTALOUTPUTANDTHEPRICELEVELATWHICHTHEGOODSANDMONEYSECTORSARESIMULTANEOUSLYINEQUILIBRIUMALONGTHEADCURVE,NOMINALMONEYSUPPLYISASSUMEDTOBECONSTANT2THECLASSICALAGGREGATESUPPLYCURVEISVERTICAL,SINCETHECLASSICALMODELASSUMESTHATNOMINALWAGESALWAYSADJUSTIMMEDIATELYTOCHANGESINTHEPRICELEVELTHISIMPLIESTHATTHELABORMARKETISALWAYSINEQUILIBRIUMANDOUTPUTISALWAYSATTHEFULLEMPLOYMENTLEVELIFTHEADCURVESHIFTSTOTHERIGHT,FIRMSTRYTOINCREASEOUTPUTBYHIRINGMOREWORKERS,ANDTHEYTRYTOATTRACTTHEMBYOFFERINGHIGHERNOMINALWAGESHOWEVER,SINCEWEAREALREADYATFULLEMPLOYMENT,THEOVERALLWORKFORCEDOESNOTINCREASE,SOFIRMSMERELYBIDUPNOMINALWAGESTHENOMINALWAGEINCREASEISPASSEDONINTHEFORMOFHIGHERPRODUCTPRICESSINCETHELEVELOFWAGESANDPRICESWILLHAVEINCREASEDPROPORTIONALLY,THEREALWAGERATEANDTHELEVELSOFEMPLOYMENTANDOUTPUTWILLREMAINUNCHANGEDIFTHEREISADECREASEINDEMAND,WORKERSAREWILLINGTOACCEPTLOWERNOMINALWAGESTOSTAYEMPLOYEDLOWERWAGECOSTSENABLEFIRMSTOLOWERTHEIRPRICES,ANDULTIMATELYNOMINALWAGESANDPRICESDECREASEPROPORTIONALLYWHILETHEREALWAGERATEANDTHELEVELSOFEMPLOYMENTANDOUTPUTREMAINTHESAME3THEAGGREGATESUPPLYCURVESHOWSTHERELATIONSHIPBETWEENTHETOTALOUTPUTTHATFIRMSAREWILLINGTOSUPPLYANDTHEAVERAGEPRICELEVELINANECONOMYTHEREAREVARIOUSTHEORIESOFHOWTHISCURVESHOULDBEDERIVEDCOMPETINGEXPLANATIONSEXISTFORTHEFACTTHATFIRMSHAVEATENDENCYTOINCREASETHEIROUTPUTLEVELASTHEPRICELEVELINCREASESTHEKEYNESIANMODELOFAHORIZONTALAGGREGATESUPPLYCURVESUPPOSEDLYDESCRIBESTHEVERYSHORTRUNOVERAPERIODOFAFEWMONTHSORLESS,WHILETHECLASSICALMODELOFAVERTICALAGGREGATESUPPLYCURVEISSUPPOSEDTOHOLDTRUEFORTHELONGRUNAPERIODOFMORETHAN10YEARSTHEMEDIUMRUNAGGREGATESUPPLYCURVEISMOSTUSEFULFORPERIODSOFSEVERALQUARTERSORAFEWYEARSTHISUPWARDSLOPINGAGGREGATESUPPLYCURVERESULTSFROMTHEFACTTHATWAGEANDPRICEADJUSTMENTSARESLOWANDUNCOORDINATEDCHAPTER6OFFERSSEVERALEXPLANATIONSFORTHEFACTTHATLABORMARKETSDONOTADJUSTVERYQUICKLYTHESEINCLUDETHEIMPERFECTINFORMATIONMARKETCLEARINGMODEL,THEEXISTENCEOFWAGECONTRACTSORCOORDINATIONPROBLEMS,ANDTHEFACTSTHATFIRMSPAYEFFICIENCYWAGESANDPRICECHANGESTENDTOBECOSTLY4THEKEYNESIANAGGREGATESUPPLYCURVEISHORIZONTALSINCETHEPRICELEVELISASSUMEDTOBEFIXEDITISMOSTAPPROPRIATEFORTHEVERYSHORTRUNAPERIODOFAFEWMONTHSORLESSTHECLASSICALAGGREGATESUPPLYCURVEISVERTICALANDOUTPUTISASSUMEDTOBEFIXEDATITSPOTENTIALLEVELITISMOSTAPPROPRIATEFORTHELONGRUNAPERIODOFMORETHAN10YEARSWHENPRICESAREABLETOFULLYADJUSTTOALLSHOCKSNEITHEROFTHESETWOAGGREGATESUPPLYCURVESDESCRIBESAVERYREALISTICORINTERESTINGSCENARIOTHEMEDIUMRUNAGGREGATESUPPLYCURVEISUPWARDSLOPINGSINCEWAGEANDPRICEADJUSTMENTSAREASSUMEDTOBESLOWANDUNCOORDINATEDTHISSCENARIOISMOREREALISTICANDMOSTUSEFULFORPERIODSOFSEVERALQUARTERSORAFEWYEARS5THEAGGREGATESUPPLYANDAGGREGATEDEMANDMODELUSEDINMACROECONOMICSSHOULDNOTBECONFUSEDWITHTHEMARKETDEMANDANDMARKETSUPPLYMODELUSEDINMICROECONOMICSWHILETHEWORKINGSOFBOTHMODELSTHEDISTINCTIONBETWEENSHIFTSOFTHECURVESVERSUSMOVEMENTALONGTHECURVESARESIMILAR,THESETWODISTINCTMODELSAREUNRELATEDTHE“P“INTHEMICROECONOMICMODELSTANDSFORTHERELATIVEPRICEOFAGOODORTHERATIOATWHICHTWOGOODSARETRADED,WHEREASTHE“P“INTHEMACROECONOMICMODELSTANDSFORTHEAVERAGEPRICELEVELOFALLGOODSANDSERVICESPRODUCEDINTHISCOUNTRY,MEASUREDINMONEYTERMSTECHNICALPROBLEMS1AASFIGURE511SHOWS,ADECREASEININCOMETAXESSHIFTSBOTHTHEADCURVEANDTHEASCURVETOTHERIGHTTHESHIFTINTHEADCURVETENDSTOBEFAIRLYLARGEAND,INTHEVERYSHORTRUNWHENPRICESAREFIXED,LEADSTOASIGNIFICANTINCREASEINOUTPUTWITHOUTACHANGEINPRICESBUTINTHELONGRUN,THEASCURVEWILLALSOSHIFTTOTHERIGHTSINCELOWERINCOMETAXRATESPROVIDEANINCENTIVETOWORKMORE,OUTPUTWILLINCREASE,BUTONLYBYAFAIRLYSMALLAMOUNTTHEREFOREWESEEALARGEINCREASEINTHEPRICELEVELWITHASLIGHTLYHIGHERLEVELOFREALGDPINTHELONGRUN1BSUPPLYSIDEECONOMICSINCLUDESANYPOLICYMEASURETHATWILLINCREASEPOTENTIALGDPBYSHIFTINGTHELONGRUNVERTICALASCURVETOTHERIGHTSUPPLYSIDEECONOMISTSPUTFORTHTHEVIEWTHATACUTININCOMETAXRATESWILLINCREASETHEINCENTIVETOWORK,SAVE,ANDINVESTSOMEECONOMISTSCLAIMEDTHATTHISWOULDINCREASEAGGREGATESUPPLYSOMUCHTHATTHEINFLATIONANDUNEMPLOYMENTRATESWOULDSIMULTANEOUSLYDECREASE,ANDTHATTHERESULTINGHIGHECONOMICGROWTHMIGHTEVENLEADTOANINCREASEINTAXREVENUES,DESPITELOWERTAXRATESHOWEVER,WHENTHESEPOLICIESWEREIMPLEMENTEDINTHEEARLY1980S,THEYDIDNOTHAVETHEPREDICTEDEFFECTSASSEENINFIGURE511,THELONGRUNEFFECTOFATAXCUTONOUTPUTISSMALL,BUTTHEPRICELEVELMAYINCREASESUBSTANTIALLY2APADOAD1ASP1PO0YOY1YACCORDINGTOTHEBALANCEDBUDGETTHEOREM,ASIMULTANEOUSANDEQUALINCREASEINGOVERNMENTPURCHASESANDTAXESWILLSHIFTTHEADCURVETOTHERIGHT,ASTHEPOSITIVEIMPACTOFTHEINCREASEINGOVERNMENTSPENDINGISGREATERTHANTHENEGATIVEIMPACTOFTHETAXINCREASEBUTIFTHEASCURVEISUPWARDSLOPING,THENTHEBALANCEDBUDGETMULTIPLIERWILLBELESSTHANONE,THATIS,THEINCREASEINOUTPUTWILLBELESSTHANTHEINCREASEINGOVERNMENTPURCHASESTHISOCCURSBECAUSEPARTOFTHEFISCALEXPANSIONWILLBECROWDEDOUT,THATIS,THELEVELOFPRIVATESPENDINGWILLDECREASE,DUETOAHIGHERPRICELEVEL,LOWERREALMONEYBALANCES,ANDTHERESULTINGRISEININTERESTRATES2BINTHEKEYNESIANCASE,THEASCURVEISHORIZONTALANDTHEPRICELEVELREMAINSUNCHANGEDTHEREISNOREALBALANCEEFFECTANDTHEREFOREINCOMEINCREASESMORETHANIN2A,THATIS,OUTPUTINCREASESBYTHEWHOLESHIFTINTHEADCURVEHOWEVER,THEINT