– Current Blog Posts: AS Policy & Tools
For many years the supply sector was minimized in macroeconomic discussions. In those discussions, the focus was on aggregate demand (AD) and how changes in AD produced changes in output and employment. If the central bank wanted output to be higher, it would use an expansionary monetary policy that would cause households and firms to spend more. If the central bank didn’t supply enough stimuli the government might chip in some fiscal stimulus with an income tax cut or by spending more itself. As a result firms would produce more. End of story.
Not everyone was satisfied with that AD story even back in the early 1960s. The story could not explain why firms would sometimes react quite quickly to increases in AD while at other times the response was smaller and slower. That story could not explain why some increases in AD were met largely with increases in prices and inflation; while at other times most of the response was to change the volume of production. That AD story was also not very satisfying when it came to explaining stagflation and it hardly had anything to say about longer-term economic growth and the main things that led to changes in a country’s standard of living. The AD approach is simply too one-sided. It leaves out a lot of microeconomics. It is silent about another approach that policy makers can take to impact the economy – AS policy.
The purpose of this note is to balance our macroeconomic approach so it contains elements of both AD and AS.
We will see how this balanced model helps us better understand many of the things discussed above. We begin by reviewing how microeconomics provides the building blocks of the AS curve and move on to a full analysis of AS shocks and policies. Finally we turn to a discussion of short- and long-term AS issues and policies.