Macroeconomics

‭turn,‬ ‭raises‬ ‭interest‬ ‭rates‬ ‭(the‬ ‭cost‬ ‭of‬ ‭borrowing)‬ ‭in‬ ‭the‬ ‭fnancial‬ ‭markets.‬ ‭Higher‬ ‭interest‬ ‭rates‬ ‭discourage‬ ‭private‬ ‭sector‬ ‭borrowing‬ ‭and‬‭investment‬ ‭because‬‭it‬‭becomes‬‭more‬‭expensive‬‭to‬‭fnance‬ ‭projects and purchases.‬ ‭For‬ ‭instance,‬ ‭if‬ ‭the‬ ‭government‬ ‭borrows‬ ‭extensively‬ ‭to‬ ‭fund‬‭its‬‭$20‬‭billion‬‭spending‬‭increase‬‭and‬‭this‬ ‭causes‬ ‭interest‬ ‭rates‬ ‭to‬ ‭rise‬ ‭signifcantly,‬ ‭businesses‬ ‭and‬ ‭individuals‬ ‭may‬‭cut‬‭back‬‭on‬‭their‬‭borrowing‬ ‭and‬ ‭investment.‬ ‭This‬ ‭reduction‬ ‭in‬ ‭private‬ ‭sector‬ ‭spending‬ ‭offsets‬ ‭some‬ ‭of‬ ‭the‬ ‭initial‬ ‭increase‬ ‭in‬ ‭government spending‬ ‭.‬ ‭The‬‭outcome‬‭depends‬‭on‬‭the‬‭relative‬‭strengths‬‭of‬‭these‬‭two‬‭effects‬ ‭.‬‭If‬‭the‬‭multiplier‬‭effect‬‭is‬ ‭much‬ ‭larger‬‭than‬ ‭the‬‭crowding-out‬‭effect,‬‭then‬‭the‬‭overall‬‭impact‬‭of‬‭fscal‬‭policy‬‭will‬‭be‬‭substantial,‬‭and‬‭it‬‭will‬ ‭effectively‬ ‭boost‬ ‭aggregate‬ ‭demand‬ ‭.‬ ‭However,‬ ‭if‬ ‭the‬ ‭crowding-out‬‭effect‬‭is‬‭signifcant‬‭and‬‭outweighs‬ ‭the multiplier effect, the fscal policy may not have as large an impact as expected.‬ ‭Economists‬ ‭study‬ ‭these‬ ‭effects‬ ‭to‬ ‭understand‬ ‭how‬‭fscal‬‭policies‬‭will‬‭play‬‭out‬‭in‬‭the‬‭real‬‭world‬‭and‬‭to‬ ‭help policymakers make informed decisions about government spending and taxation.‬ ‭Aggregate‬ ‭supply‬ ‭(AS)‬ ‭is‬‭a‬‭macroeconomic‬‭concept‬‭that‬‭represents‬ ‭the‬‭total‬‭output‬‭or‬‭real‬‭GDP‬‭that‬ ‭producers in an economy are willing and able to supply‬ ‭at a given price during a certain period of time.‬ ‭The‬ ‭difference‬ ‭between‬ ‭the‬ ‭aggregate‬ ‭demand‬ ‭and‬ ‭aggregate‬ ‭supply‬ ‭curves‬ ‭is‬ ‭that‬ ‭the‬ ‭AS‬ ‭curve‬ ‭is‬ ‭studied‬ ‭in‬ ‭the‬‭short‬‭run‬‭and‬‭in‬‭the‬‭long‬‭run,‬‭resulting‬‭in‬‭two‬‭different‬‭graphs.‬‭Before‬‭introducing‬‭these‬ ‭graphs, let us differentiate between the short run and the long run in economics.‬ ‭Sticky vs. Flexible Wages and Prices‬ ‭●‬ ‭Short‬ ‭Run:‬ ‭In‬ ‭macroeconomics,‬ ‭the‬ ‭short‬ ‭run‬ ‭is‬‭a‬‭period‬‭during‬‭which‬ ‭the‬‭price‬‭or‬‭cost‬‭of‬‭at‬ ‭least‬‭one‬‭input‬‭or‬‭factor‬‭of‬‭production‬‭(such‬‭as‬‭land,‬‭labor,‬‭capital,‬‭and‬‭enterprise)‬‭is‬‭fxed‬ ‭and‬ ‭cannot‬ ‭change‬ ‭.‬ ‭For‬‭example,‬‭if‬‭wages‬‭are‬‭locked‬‭at‬‭a‬‭certain‬‭level,‬‭this‬‭indicates‬‭that‬‭the‬ ‭economy‬ ‭is‬ ‭operating‬ ‭in‬ ‭the‬ ‭short‬ ‭run.‬ ‭In‬ ‭other‬ ‭words,‬ ‭it‬ ‭is‬ ‭diffcult‬ ‭to‬ ‭adjust‬ ‭the‬ ‭factors‬ ‭of‬ ‭production‬ ‭in‬ ‭the‬ ‭short‬ ‭run‬ ‭to‬ ‭achieve‬ ‭the‬ ‭optimal‬ ‭level‬ ‭of‬ ‭output.‬ ‭When‬‭these‬‭factors‬‭do‬‭not‬ ‭adapt‬‭quickly,‬‭economists‬‭refer‬‭to‬‭them‬‭as‬ ‭"sticky."‬ ‭For‬‭instance,‬‭when‬‭market‬‭prices‬‭or‬‭wages‬ ‭do‬ ‭not‬ ‭adjust‬ ‭promptly‬ ‭to‬ ‭changes‬ ‭in‬ ‭the‬ ‭economy,‬ ‭they‬ ‭are‬ ‭referred‬ ‭to‬ ‭as‬ ‭sticky‬‭prices.‬ ‭It‬‭is‬ ‭believed‬‭that‬‭frms‬‭might‬‭not‬‭change‬‭their‬‭prices‬‭when‬‭there‬‭is‬‭a‬‭change‬‭in‬‭the‬‭general‬‭price‬ ‭level‬ ‭because‬ ‭of‬ ‭menu‬ ‭costs‬ ‭that‬ ‭make‬ ‭it‬‭costly‬‭to‬‭do‬‭so.‬‭Recall‬‭that‬‭menu‬‭costs‬‭refer‬‭to‬‭the‬ ‭costs‬ ‭of‬ ‭replacing‬ ‭menus,‬ ‭brochures,‬ ‭price‬ ‭tags,‬ ‭etc.,‬ ‭when‬ ‭prices‬ ‭increase.‬ ‭They‬ ‭have‬ ‭been‬ ‭proposed as one of the reasons why prices are “sticky” in an economy.‬ ‭●‬ ‭Long‬‭Run:‬ ‭In‬‭contrast,‬‭the‬‭long‬‭run‬‭involves‬ ‭no‬‭fxed‬‭inputs‬ ‭.‬ ‭All‬‭prices‬‭and‬‭costs‬‭are‬‭variable‬ ‭and‬‭can‬‭be‬‭adjusted‬ ‭to‬‭attain‬‭the‬‭optimal‬‭level‬‭of‬‭production‬‭effciency‬‭and‬‭cost-effectiveness.‬ ‭In this scenario,‬ ‭there are no sticky prices or wages‬ ‭.‬ ‭The crowding-out effect will be explained in more detail in Chapter 5.‬ ‭D. Aggregate Supply (AS)‬

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