AP MACRO-MR. LIPMAN KRUGMAN’S UNIT 4.ppt

If dollar depreciates, more Europeans will buy US products causing Net Exports to increase * * * * * * ? * ? * Short-Run Versus Long-Run Effects of a Positive Demand Shock and a return to Equilibrium via self- correcting economy. * Long Term Equilibrium To summarize how an economy responds to recessions/inflation we focus on Output Gap which is the % difference between actual aggregate output and potential output. Actual Aggregate Output-Potential Output x 100 Potential Output In the Long Run the economy is self-correcting but many times Governments are not willing to wait that long which brings about Macroeconomic Policy (Module 20) * Adam Smith 1723-1790 John Maynard Keynes 1883-1946 * MODULE 20 Classical vs. Keynesian Economic Theory * * * Debates Over Aggregate Supply Classical Theory A change in AD will not change output even in the short run because prices of resources (wages) are very flexible. AS is vertical so AD can’t increase without causing inflation. Price level Real domestic output, GDP AS Qf AD * Recessions caused by a fall in AD are temporary. Price level will fall and economy will fix itself. No Government Involvement Required AD1 * Debates Over Aggregate Supply Keynesian Theory A decrease in AD will lead to a persistent recession because prices of resources (wages) are NOT flexible. Increase in AD during a recession puts no pressure on prices Price level Real domestic output, GDP AS Qf AD * Q1 “Sticky Wages” prevents wages to fall. The government should increase spending to close the gap AD1 * Debates Over Aggregate Supply Keynesian Theory A decrease in AD will lead to a persistent recession because prices of resources (wages) are NOT flexible. Increase in AD during a recession puts no pressure on prices Price level Real domestic output, GDP AS Qf AD2 * AD1 Q1 When there is high unemployment, an increase in AD doesn’t lead to higher prices until you get close to full employment AD3 * The Ratchet Effect A ratchet (socket wrench)