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Finally, consider the intermediate zone    of the SRAS curve in [link] . If the AD curve crosses this portion of the SRAS curve at an equilibrium point like Ei, then we might expect unemployment and inflation to move in opposing directions. For instance, a shift of AD to the right will move output closer to potential GDP and thus reduce unemployment, but will also lead to a higher price level and upward pressure on inflation. Conversely, a shift of AD to the left will move output further from potential GDP and raise unemployment, but will also lead to a lower price level and downward pressure on inflation.

This approach of dividing the SRAS curve into different zones works as a diagnostic test that can be applied to an economy, like a doctor checking a patient for symptoms. First, figure out what zone the economy is in and then the economic issues, tradeoffs, and policy choices will be clarified. Some economists believe that the economy is strongly predisposed to be in one zone or another. Thus, hard-line Keynesian economists believe that the economies are in the Keynesian zone most of the time, and so they view the neoclassical zone as a theoretical abstraction. Conversely, hard-line neoclassical economists argue that economies are in the neoclassical zone most of the time and that the Keynesian zone is a distraction. The Keynesian Perspective and The Neoclassical Perspective should help to clarify the underpinnings and consequences of these contrasting views of the macroeconomy.

From housing bubble to housing bust

Economic fluctuations, whether those experienced during the Great Depression of the 1930s, the stagflation of the 1970s, or the Great Recession of 2008–2009, can be explained using the AD/AS diagram. Short-run fluctuations in output occur due to shifts of the SRAS curve, the AD curve, or both. In the case of the housing bubble, rising home values caused the AD curve to shift to the right as more people felt that rising home values increased their overall wealth. Many homeowners took on mortgages that exceeded their ability to pay because, as home values continued to go up, the increased value would pay off any debt outstanding. Increased wealth due to rising home values lead to increased home equity loans and increased spending. All these activities pushed AD to the right, contributing to low unemployment rates and economic growth in the United States. When the housing bubble burst, overall wealth dropped dramatically, wiping out the recent gains. This drop in the value of homes was a demand shock to the U.S. economy because of its impact directly on the wealth of the household sector, and its contagion into the financial that essentially locked up new credit. The AD curve shifted to the left as evidenced by the rising unemployment of the Great Recession.

Understanding the source of these macroeconomic fluctuations provided monetary and fiscal policy makers with insight about what policy actions to take to mitigate the impact of the housing crisis. From a monetary policy perspective, the Federal Reserve lowered short-term interest rates to between 0% and 0.25 %, to loosen up credit throughout the financial system. Discretionary fiscal policy measures included the passage of the Emergency Economic Stabilization Act of 2008 that allowed for the purchase of troubled assets, such as mortgages, from financial institutions and the American Recovery and Reinvestment Act of 2009 that increased government spending on infrastructure, provided for tax cuts, and increased transfer payments. In combination, both monetary and fiscal policy measures were designed to help stimulate aggregate demand in the U.S. economy, pushing the AD curve to the right.

While most economists agree on the usefulness of the AD/AS diagram in analyzing the sources of these fluctuations, there is still some disagreement about the effectiveness of policy decisions that are useful in stabilizing these fluctuations. We discuss the possible policy actions and the differences among economists about their effectiveness in more detail in The Keynesian Perspective , Monetary Policy and Bank Regulation , and Government Budgets and Fiscal Policy .

Key concepts and summary

The SRAS curve can be divided into three zones. Keynes’ law says demand creates its own supply, so that changes in aggregate demand cause changes in real GDP and employment. Keynes’ law can be shown on the horizontal Keynesian zone of the aggregate supply curve. The Keynesian zone occurs at the left of the SRAS curve where it is fairly flat, so movements in AD will affect output, but have little effect on the price level. Say’s law says supply creates its own demand. Changes in aggregate demand have no effect on real GDP and employment, only on the price level. Say’s law can be shown on the vertical neoclassical zone of the aggregate supply curve. The neoclassical zone occurs at the right of the SRAS curve where it is fairly vertical, and so movements in AD will affect the price level, but have little impact on output. The intermediate zone in the middle of the SRAS curve is upward-sloping, so a rise in AD will cause higher output and price level, while a fall in AD will lead to a lower output and price level.

Questions & Answers

objective of macro economic
saroj Reply
give the characteristics of good money?
Chok Reply
suppose that there is a positive aggregate demand shock. what graph most accurately show how this would affect the aggregate demand-aggregate supply model?
Shielyn Reply
ppf and ad/as
jax
PPF , AD/AS
Shubham
if there is advance technology in the fishing industry, how will this change in supply and demand
El Reply
yes
Shehazahd
increase Supply, since technology in fishing will increase the efficiency of fishing , higher productivity and thus lower per unit cost of production, which incentive producers to increase their supply. demand wise, not so sure. depends on what exactly is the advancement in tech.
samantha
how many types of natural rate of unemployment
Trina Reply
what is macro economic
muniira Reply
in the year 1933, Ragnar Frisch used the term macro
Ammu
factors that determine the country material standard ?
Serena Reply
population divide by gdp in currency analysis
Aniyikayekenny
what is the important of studying economics
Akurugu Reply
economics teaches you how to think not what think
umer
in order to know how our country operates and corporate with other countries based on the international marketing and to know how our economy is doing regarding incomes going in and out through exchange of goods and services,we have to study more about economics to gain more and better understanding
Betty
important studying economic is make a choice under the condition of scarcity
cafifo
is labour a intermediate good or final good
umer Reply
what is economics
Mahamed Reply
Economic is science, which Studies human behaviour and who they are earn and spend
Ammu
economics is the science which shows how can use scare resources among society
umer
economic is a science which study human behavior as a result relationship between ends at scarce means which have more than one use
Jovert
simply, economics is a science which studies human wants,
Saeed
Economy is knowledge of choice
Omid
how to derive the equation for the equilibrium level of national income in an open economy with no taxes
loise Reply
what is inflation?
Herry Reply
when price goes up with some shottime
umer
Give me 5 example for Macro economics
Neha Reply
1. Markets 2. Market Failure 3. Competition 4. Price Stability 5. Efficiency
Luyando
please can you explain markets and markets failure ?
Timothy
When we talk about Markets as an example of macroeconomics, we look at demand and supply in labor market.
Luyando
Then for market failures, we focus on market inefficiencies and failures such as the destruction of common goods due to economic systems that provide no incentive for their preservation
Luyando
Who is a discourage worker.?
Timothy
a discourage worker is simply a worker who stop looking for a job because he/she believe no job is available for them..
Joseph
sloping curve normal
Mirasol Reply
A normal sloping curve
Mirasol
State what happen to the aggregate supply curve for beef. The price of beef decrease
Mirasol
i think there is positive relationship between price n supply so as the price decreases the supply curve so decreases and vice versa
Dharani
quantity supply will decrease,less.profit for firms in a perfectly competitive market i guess
Joseph
yaa
Dharani
List two REASONS FOR LOW PRODUCTIVITY IN DEVELOPING COUNTRIES?
KHONAYE Reply
DESCRIBE WHY MARGINALISED GROUPS ARE NORMALLY AFFECTED FIRST DURING A RECESSION.I'M IN GRADE 11
KHONAYE
A normal sloping curve
Mirasol

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Source:  OpenStax, Macroeconomics. OpenStax CNX. Jun 16, 2014 Download for free at http://legacy.cnx.org/content/col11626/1.10
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