Chapter Summary

In this chapter, we have tried to make the Aggregate Supply-Aggregate Demand model more understandable, and at the same time to test its usefulness, by applying it to some practical issues of economic policy.

• We have seen that changes in Aggregate Demand, such as might result from monetary policy or fiscal policy or changes in saving behavior, will have somewhat less impact on output in the short run, and much less impact on output in the long run, than the Simple Keynesian Model would have suggested. The difference will be taken up by changes in the price level. It follows that these concepts are more useful in understanding (and dealing with) short-term economic fluctuations than longer-term economic changes.
• We have applied the concept of aggregate supply to the relationship between economic growth and inflation. We see that a stable price level over time would require a "balanced growth" of both aggregate demand and supply.
• Perhaps the biggest issue we have taken up is the proposal for a "Supply Side" tax cut, a proposal which seems to come and go fairly regularly in American politics. This proposal can be analyzed in terms of the AS-AD model. Those who come to the discussion with different views on the Supply Side proposal will probably take different lessons away from the discussion. Those who come favoring the proposal probably will take away the lesson that it is possible for such a policy to succeed. Those who come opposed to the policy will probably take away the lesson that it is very improbable that it would succeed. Both would be right.

All in all, then, the AS/AD model seems a workable tool for economic analysis -- too simple to be simply "true," too complex to be "common sense," but simple enough and true enough to be useful.

Next Chapter: Controversies in
Macroeconomics 1: Monetarism and the Policy Ineffectiveness Proposition

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