Appendix: A More Dynamic Approach to Aggregate Supply and Demand

NOTE -- this appendix was compiled about 2000 from several parts of several experimental chapter drafts and is UNCORRECTED. Use at your own risk.

A recent news story says that the Governors of the Federal Reserve System are concerned about future trends toward inflation. They feel that production is growing too fast, and they feel that this fast growth will lead to faster inflation. They want to take measures to slow down the growth of production so as to prevent inflation.

In other words, the kinds of words we would use in the macroeconomics chapters of this book, they are concerned that Aggregate Demand is increasing faster than Aggregate Supply. Amy texts use the Aggregate Demand -- Aggregate Supply approach. It has the advantage of familiar terminology and can draw on what the student has learned in the microeconomics of supply and demand. Neverthless, it has been criticised on several grounds:

It underplays the very real differences between microeconomic and macroeconomic "Supply" and "Demand" concepts. The very existence of Aggregate Supply is questionable, and Aggregate Demand is, at least, a more complex concept than microeconomic demand.
It suggests that aggregate economic relationships are static, and they clearly are not. The first paragraph about the concerns of the Fed Governors illustrates this: it is all in terms of rates of change.
It does not represent the world as the Fed sees it.

The last is in some ways the most important. On the one hand, the Fed has access to the best economic expertise in the world. It would not be easy to improve on their ideas of American macroeconomics. But even if they are wrong, their view of things has a great impact on reality because it guides their policy. So it is valuable to understand the world as the Fed understands it.

The balance of this appendix is an attempt to do that, without getting too deeply into specialized research in macroeconomics. We will explore a model of macroeconomic equilibrium based on relationships between rates of change.

This model parallels the "Aggregate Supply -- Aggregate Demand" model in several chapters of the main text, so the different sections will call on knowledge from different chapters. I'll try to alert you along the way.

Next: The Friedman Curve