Question

1. In your view is the United States economy currently operating in the Keynesian, intermediate, or neoclassical portion of the economy’s Short Run Aggregate Supply Curve? Explain your answer carefully using the information that you have gathered regarding real GDP, unemployment, the GDP deflator, and inflation in the previous discussions. You will want to discuss the concepts of potential GDP and the natural rate of unemployment to receive full credit.

2. Explain why it might be important for policymakers to know which zone of the Short Run Aggregate Supply Curve (SRAS) is currently operating in?

Answer 1

1.The US economy, is experiencing a growth rate that is fuelled by rise in aggregate demand , given that , the various entities –consumers or households, firms, government and financial and other economic transactions related to the other countries and trading partners of the US across the world—are actively contributing to the rise in the US GDP.

The rate of rise of GDP might however vary depending on the influence of the macro economic variables like aggregate savings, investment, household spending and so on.

The Keynesian Economic theory advocates a ‘near to ‘ full employment equilibrium rather than a full employment equilibrium—it states that it is not practical to assume that the economy might always stabilise at a situation where all its given resources are fully employed –hence full employment is near to full employment situation (which was earlier advocated by classicals and monetarists ) and that too for short or relatively medium time periods !!.Stability and more importantly, growth is possible only at a position which is , lets say -96% employment of all the resources.

The neo- classical theory, on the other hand, assumes growth at full employment rather than under employment equilibrium—it believes in the two macro-economic variables of 1. Savings and 2. Investment – to influence economic growth, a thought that believes that per capita income primarily leads to economic growth—which is rather considered an outdated and traditional version , since modern day economists believe that economic growth development depends upon series of developments which consider qualitative variables like standard of living, happiness index, literacy ratio and so on.

The neo classical short run supply curve shows the total output which the firms are prepared to supply given the prices, and the available resources. A rise in the aggregate demand, will, most likely lead to rise in the overall output if the resources are available to meet the rise in demand, if not it will likely lead to a rise in the general price level (assuming that output cannot be matched to rise in demand in the short run)—however this is not sustained—the output will rise over long periods of time and the full employment level of equilibrium will be regained.

The important indicators like , the real GDP—which is the GDP adjusted for inflation – shows a marginal rise , and the GDP deflator , which shows the imputed GDP , taking into account the base years’ prices, shows that the inflationary effect is off set by rise in aggregate spending—consisting of both the government and the households, firms as well as the rest of the world’s trading and investment activities in the US economy.

The effects of potential GDP—planned aggregate spending and aggregate supply, associated with long run time period, is however, a cumulation of short run experiences of the US economy’s growth and a well-formed forecast of the changes in future. Naturally, this would lead to the inclusion rate of unemployment of the resources ta the full employment equilibrium—or the concept of natural rate of unemployment—which would be at its lowest since the planned aggregate demand in the long run will be met by the planned or the expected supply and hence the economy is expected to retain its equilibrium position in the long run

The US economy is, in a given time period, with given resources, more likely to operate in a near to full employment equilibrium rather than full employment equilibrium. The near to equilibrium is more practical since the economy is experiencing growth both form quantitative variables like savings, investment and from qualitative variables like effects of government spending on welfare measures and so on.

2. It is very important for policy makers to understand the SRAS and the zone or the area of the curve the economy is currently operating, in order to understand the macro economic implications of such a position and the relevant policies that will be needed to tackle disturbances, if any , which arise from such a position . It is also necessary since , the policy makers will have to formulate their long run policies based on such short run experiences.

The US economy is facing a rise in consumption spending by households , as also an effect of the positive rise in expenditure that risen due to rise in government spending. There is also evidence of the effects of rise in the investments made by foreign nationals—both in the form of direct investment and portfolio investment , which has increased the aggregate investment in the economy.

If the rise in aggregate demand is met by rise in output the net effect would be lower levels of inflation or to say in simple words, a healthy inflation, on the other hand if the aggregate demand is more than the aggregate output or supply , it will cause a rise in the general price level .

On the other hand , if the   aggregate demand is less than the available supply then it will be a situation of deficient demand which could affect the investment atmosphere adversely.

Hence , its very important for the policy makers to monitor the situation in the short run and form their policies , more specifically keeping the long run equilibrium perspective in mind.