Macroeconomic Perspectives on Demand and Supply
Say’s Law and the Macroeconomics of Supply
● “Supply creates its own demand”
- Each time a god/service is produced and sold, it generates income that is earned
for someone who is at firms that supply inputs along the chain of production
- A good approximation for the long run
● Neoclassical economists - generally subscribe to Say’s law view on the importance of
supply for determining the size of the macroeconomy
● If supply always creates exactly enough demand at the macroeconomic level, then it is
hard to understand why periods of recession and high unemployment should ever occur
● Recession - the economy as a whole is shrinking in size, business failures outnumber
the remaining success, and many firms end up suffering losses and laying off workers
Keynes’ Law and the Macroeconomics of Demand
● “Demand creates its own supply”
- The economy’s capacity to supply goods/services had not changed much
- Unemployment rates increase, but the number of possible workers did not
increase/decrease
- Factories closed, but machinery and equipment had not disappeared
- The economy often produced less than its full potential, not because it can’t
technologically, but because they lack demand
- GDP is determined by the amount of total demand
- Applies fairly well in the short run
● Economies face genuine limits to how much they can produce (limits by labor, capital,
technology, and market)
- These constraints do not disappear just because of an increase in demand
Combining Supply and Demand in Macroeconomics
● An economic approach focused only on the supply side or only on the demand side can
be only a partial success
- Need to take into account both supply and demand
● Since Keynes’ law applied more accurately in the short run and Say’s law in the long
run, the tradeoffs and connections between the three goals of macroeconomics may be
different in the short and long run
Building a Model of Aggregate Demand and Aggregate Supply
The Aggregate Supply Curve and Potential GDP
● Aggregate supply (AS) - total quantity of output (i.e. real GDP) firms will produce and sell
● AS curve - shows total quantity of output that firms will produce and sell at each price
level
● As the price level rises, real GDP rises
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