Question

Imagine you are the chief economist for the President. The President has asked you to develop a policy that he can announce during the upcoming State of the Union Address. Your staff knows the President has a fondness for the SAS-AD model. Unfortunately you can't you give him solid policy prescriptions based on that model because you do not know the location of the LAS curve. Explain why that is a serious problem. What are the consequences of enacting fiscal policies without knowing the LAS curve.

Answer 1

LAS curve or the Long-run Aggregate Supply curve is the potential stage the economy can reach. It represents the idea equilibrium where the Short-run aggregate supply curve and the short-run aggregate demand curve will meet. At this equilibrium, there will be no inflation and no deflation. This point is decided by the position of the LAS curve.

IF the equilibrium point is before the LAS curve there will be deflation and if the equilibrium point is beyond the LAs curve there will be inflation. TO know the position where the economy is operating i.e. inflation or deflation and use a policy to control that situation knowing the LAS is very important. Without that, we can not read to an ideal equilibrium and achieve a stable business cycle.

IF the LAS is not known we can increase the inflation when we are already having an excess demand or decrease the price level when the demand is already down. We will never reach an ideal situation without knowing the LAS.