ECON 140W - Week 11

Class - Mar. 24, 2026

Long-Run Aggregate Supply

How much is produced in a stable economy?
Equal to potential output: Level of output at full employment
Classical Dichotomy
In the long-run, money is "neutral" and if everybody had more money, it doesn't necessarily change anything
It affects prices but not output

THIS IS A VERTICAL CURVE!

AD-AS in the Very Short Run

In the very short-run, prices are assumed to be fixed
Very short-run aggregate supply curve is horizontal
- Economy is demand-determined
- Suppliers produce whatever is demanded
- Equivalent to the IS-MP-PC model
  (THIS IS JUST A HORIZONTAL LINE) and everything is demand-determined

Short to Medium Run

This is a process that generally takes months
If there is a positive output gap, prices rise (demand-pull inflation)
If there is a negative output gap, prices fall (negative demand-pull inflation)
- Aggregate supply curve rotates to an upward sloping line
- Rotation around the point where the output gap is zero

Asymmetric Adjustment

In recessions, output initially falls a lot
- Prices adjust relatively slowly
- Low output, high unemployment
In a boom, output doesn't rise as much
- Prices rise more quickly
Fiscal policy more common in a recession
- Long-term unemployment is a problem
- Zero-lower bound matters
- Policy response is too slow in a boom

Class - Mar. 26, 2026

Fiscal Policy

Decisions on government spending (purchases or transfers) or taxes intended to shift the overall economy
- Short-run and long-run fiscal policy
Expansionary fiscal policy
- Higher purchases (direct) or transfers (indirect)
- Lower taxes (indirect)
Contractionary fiscal policy
- Lower purchases /transfers
- Higher taxes

Multiplier Effects

How much GDP is created when the government spends money?

\Delta GDP = \Delta G \times m$$ where G is government spending and m is the multiplier effect - Multiplier measures change in output for a change in spending - Depends on leakage (taxes, imports, savings) - Depends on type of spending - Depends on economic conditions - Slope of the AS curve ## Discretionary vs. Automatic Policy - Discretionary spending can be very slow - Recognize a problem, designing a solution, implement that solution - Expansionary fiscal policy is slow, contractionary fiscal policy is very slow - Sometimes, discretionary policy is necessary (timely, targeted, temporary) - Automatic stabilizers are a critical first step - Recessions lead tot lower tax rates and larger government transfers - Progressive tax rates and social assistance are examples - Employment insurance payouts ## Asymmetric Adjustment - Discretionary fiscal policy is most relevant when there is a large negative output gap