MacroEconomics

Public Policy
PIDE

Lecture Dated 16/06/2020

 Outline
•Equilibrium in the AD-AS
–Short run
–Long-run
•Shocks to AD/AS
•Predicting the Economy
 Equilibrium in the AS AD

• Determines Aggregate Prices and Equilibrium Real Output

• Depending on the SARS we can determine the State of the
Economy
 Shocks in AD/As and New Equilibrium
• AD -expectations/wealth/physical capital/FP/MP
– Positive Shock
– Negative Shock
• AS-Commodity prices/nominal wages/productivity
– Positive Shock
– Negative Shock
• Theory of Change-Variables and Channels,
behavioral parameters, Stability, Predictability,
Lucas Critique
 Outcomes
• Stagflation
• Inflation
• Employment
• Growth
• Potential output
 Long-run AD-As Equilibrium
• Self Correcting
• E.g. AD falls Reduction in equilibrium output/employment
Inflation going down fall back on SAS (recessionary gap)
Nominal Wages fall Shifts the SAS right and new
equilibrium is the same output at lower prices
• Flexibility in prices help adjust back to equilibrium
• If below Yp recessionary gap Prices going down along with
employment
• If above Yp inflationary gap prices going up and
employment will fall back to potential level
Predicting the Economy
 Stabilization Policy
• Government should not wait for the self
correction of markets for inflationary or
recessionary gaps
• Price stabilization, Output growth,
Unemployment
• Choice of addressing imbalance through
Demand side policies FP/MP can be risky
 Supply shock-
Demand Shock
• Addressing this
problem with
Demand
management policy
can be disastrous
• Same is the Case
with AD Side shock
and management
through AS policies
• Covid- Demand side
and Supply Shock
both
 Assignment
• Think about one variable each affecting AS
and AD and make a table of outcomes on
equilibrium price and real GDP being
produced, recession/boom tendency and ur
advice?
• Dead line 22-06-2020
• Submit at mahmood.khalid@pide.org.pk