You might say the demand and supply for what? In economics we often focus on price and quantity. Cell phones have a price and during the year, we know that cell phones are bought and sold. The price and the quantity or the changes in price and quantity from one year to the next are determined by demand factors (like how many people want to buy them) and supply factors (like how much firms decide to produce.) The amount actually traded in the market in a particular year stems from the interactions of demand and supply.  In macroeconomics, the quantity refers to all the goods and services produced in the nation (Gross Domestic Product or GDP). Price or the nation’s price level refers to the average price of all these goods and services.

It might be helpful to note that very much, though not all, of the discussion about short-term changes in a country’s economy tend to focus on AD factors. Many of us are so busy with the short-run that we never think much about the long-run. That means that we probably think that ALL of macro is about AD. But that isn’t true and we hope to explain why in this course. This note attempts to provide the background, definitions, and analysis so that you can better understand what analysts and forecasters say about AD, AD policy, and short-term changes in the economy.

We begin with a closer look at GDP and then turn to AD – its definition, its components, its causes, and its consequences. We then look at several applications involving industry considerations, international aspects, and difference of opinion.

Motivation

What happens to any firm’s revenue is a result of a combination of forces that are directly related to the company, its industry, and the domestic and international macroeconomic environment. Depending on the specific firm and the specific year, these factors might alternate in importance. In some years macroeconomic factors might not be very important. But in others – particularly at the beginning or end of a recession – changes in AD or aggregate supply (AS) can be quite important.

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Let’s cut to the chase about the reading here. Some of the stuff below sounds pretty technical. What you want to think about is how all those demand factors are going to impact your planning. But it is not that easy. The challenge is that everything you read is going to be filled with jargon. This jargon is necessary because the economy is complex. The people who write about the economy break the stories down by using specific terminology. If you are to understand what these experts are saying, then you have to master the terminology.

Macro Concepts and Analysis

Micro and Macro

We learn in microeconomics that the interaction of demand and supply is the key to understanding what happens to prices and quantities traded. We can apply this idea to any product or service to think about or explain why we end up buying and selling more or less of that product in a particular year. We might say that steel sales increased this year because appliance and auto companies were more optimistic about the future and decided to purchase more flat rolled steel. That would be a demand story. Or we could say that steel prices increased this year because steel producers paid increased prices for slag. That would be a supply tale.

Macroeconomics ignores the specific changes in particular goods or services so that it can concentrate on ALL of a nation’s production.  In macro we ask these kinds of questions: Why did the economy slow this year? Why did the recovery begin? How strong will the recovery be?

AD & AS

To answer these macro questions we think in terms of macro markets. Instead of the market for steel or consulting services, we think of the market for ALL the nation’s goods and services. AD is the total demand for ALL of a nation’s goods and services. AS is the supplies of all the nation’s goods and services. Okay – in macro we want to talk about the SUM or AGGREGATE of all these goods and services. How do you get from the thousands of different goods and services to talking about ALL of them? Al Capp, the famous cartoonist, had some fun with this idea – he talked about smooshing together all these goods and services into one unit – so he called the sum total of all goods a SCHMOO.  (For more information about SCHMOOs and how they almost destroyed mankind, see the following site: http://www.deniskitchen.com/thestore/bios_shmoo.html I thank former student Wayne Blankenbeckler for alerting me to more information on this topic.)  It turns out that most countries do not publish statistics on the price or quantity of SCHMOOs – but they do use a concept called Gross Domestic Product (GDP).  What is that?