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By the end of this section, you will be able to:
  • Explain the importance of potential GDP in the long run
  • Analyze the role of flexible prices
  • Interpret a neoclassical model of aggregate demand and aggregate supply
  • Evaluate different ways for measuring the speed of macroeconomic adjustment

The neoclassical perspective    on macroeconomics holds that, in the long run, the economy will fluctuate around its potential GDP and its natural rate of unemployment. This chapter begins with two building blocks of neoclassical economics: (1) the size of the economy is determined by potential GDP, and (2) wages and prices will adjust in a flexible manner so that the economy will adjust back to its potential GDP level of output. The key policy implication is this: Should the government focus more on long-term growth and on controlling inflation than on worrying about recession or cyclical unemployment? This focus on long-run growth rather than the short-run fluctuations in the business cycle means that neoclassical economics is more useful for long-run macroeconomic analysis and Keynesian economics is more useful for analyzing the macroeconomic short run. Let's consider the two neoclassical building blocks in turn, and how they can be embodied in the aggregate demand/aggregate supply model    .

The importance of potential gdp in the long run

Over the long run, the level of potential GDP determines the size of real GDP. When economists refer to “potential GDP” they are referring to that level of output that can be achieved when all resources (land, labor, capital, and entrepreneurial ability) are fully employed. While the unemployment rate in labor markets will never be zero, full employment in the labor market refers to zero cyclical unemployment. There will still be some level of unemployment due to frictional or structural unemployment, but when the economy is operating with zero cyclical unemployment, the economy is said to be at the natural rate of unemployment or at full employment.

Actual or real GDP    is benchmarked against the potential GDP    to determine how well the economy is performing. Growth in GDP can be explained by increases and investment in physical capital and human capital per person as well as advances in technology. Physical capital per person refers to the amount and kind of machinery and equipment available to help people get work done. Compare, for example, your productivity in typing a term paper on a typewriter to working on your laptop with word processing software. Clearly, you will be able to be more productive using word processing software. The technology and level of capital of your laptop and software has increased your productivity. More broadly, the development of GPS technology and Universal Product Codes (those barcodes on every product we buy) has made it much easier for firms to track shipments, tabulate inventories, and sell and distribute products. These two technological innovations, and many others, have increased a nation's ability to produce goods and services for a given population. Likewise, increasing human capital involves increasing levels of knowledge, education, and skill sets per person through vocational or higher education. Physical and human capital improvements with technological advances will increase overall productivity and, thus, GDP.

Questions & Answers

what's economic
kamal Reply
Management of money such as saving.
babu
Please help me how to compute national income. what are those included on national income like for an example in W= WAGE what included in wage ?
love Reply
what is competitive market?
Shantal Reply
a compataive market is when there are many producers competating to provide consumers with a goods and services needed
Tanveer
in a compitative market no single producer or consumer can dictate the market
Tanveer
types of demand elasticity
Farouq Reply
What is price elasticity of demand and its degrees. also explain factors determing price elasticity of demand?
Yutansh Reply
Price elasticity of demand (PED) is use to measure the degree of responsiveness of Quantity demanded for a given change on price of the good itself, certis paribus. The formula for PED = percentage change in quantity demanded/ percentage change in price of good A
GOH
its is necessarily negative due to the inverse relationship between price and Quantity demanded. since PED carries a negative sign most of the time, we will usually the absolute value of PED by dropping the negative sign.
GOH
PED > 1 means that the demand of the good is price elasticity and for a given increase in price there will be a more then proportionate decrease in quantity demanded.
GOH
PED < 1 means that the demand of the good is price inelasticity and for a given increase in price there will be a less then proportionate decrease in quantity demanded.
GOH
The factors that affects PES are: Avaliablilty of close substitutes, proportion of income spent on the good, Degree of necessity, Addiction and Time.
GOH
Calculate price elasticity of demand and comment on the shape of the demand curve of a good ,when its price rises by 20 percentage, quantity demanded falls from 150 units to 120 units.
Helen Reply
5 %fall in price of good x leads to a 10 % rise in its quantity demanded. A 20 % rise in price of good y leads to do a 10 % fall in its quantity demanded. calculate price elasticity of demand of good x and good y. Out of the two goods which one is more elastic.
Helen
what is labor
Grace Reply
labor is any physical or mental effort that helps in the production of goods and services
Kwabena
what is profit maximizing level of out put for above hypothetical firm TC = Q3 - 21Q2 + 600 + 1800 P = 600 MC = 3Q2 - 42Q + 600
Sosna Reply
consider two goods X and Y. When the price of Y changes from 10 to 20. The quantity demanded of X changes from 40 to 35. Calculate cross elasticity of demand for X.
Sosna
sorry it the mistake answer it is question
Sosna
consider two goods X and Y. When the price of Y changes from 10 to 20. The quantity demanded of X changes from 40 to 35. Calculate cross elasticity of demand for X.
Sosna
The formula for calculation income elasticity of demand is the percent change in quantity demanded divided by the percent change in income.
Sosna
what is labor productivity
Lizzy Reply
if the demand function is q=25-4p+p² 1.find elasticity of demand at the point p=5?
Puja Reply
what are some of the difference between monopoly and perfect competition market
Obeng Reply
n a perfectly competitive market, price equals marginal cost and firms earn an economic profit of zero. In a monopoly, the price is set above marginal cost and the firm earns a positive economic profit. Perfect competition produces an equilibrium in which the price and quantity of a good is economic
Naima
what are some characteristics of monopoly market
Obeng Reply
explicit cost is seen as a total experiences in the business or the salary (wages) that a firm pay to employee.
Idagu Reply
what is price elasticity
Fosua
...
krishna
it is the degree of responsiveness to a percentage change in the price of the commodity
Obeng
economics is known to be the field
John Reply
what is monopoly
Peter Reply
what is taxation
Peter
is the compulsory transfer of wealth from the private sector to the public sector
Jonna

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Source:  OpenStax, Principles of economics. OpenStax CNX. Sep 19, 2014 Download for free at http://legacy.cnx.org/content/col11613/1.11
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