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Figure 17.8 (Macro 4) The Ups and Downs in Interest Rates

Figure 17.8 (Macro 4) The Ups and Downs in Interest Rates

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3. Macroeconomic Theory and Policy

• 3a. Economic growth theory and economic

fluctuations theory are the long- and short-term

parts of macroeconomic theory, respectively. The

trend line of Figure 19.1 is potential GDP, or the

long-run tendency of GDP, and is an average-level

GDP that reflects the long-term growth rate, the

slope of the trend line.



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Aggregate Supply

• 3b. The term aggregate supply is used to describe

potential GDP in the short-run setting of economic

fluctuations. Aggregate supply is determined by the

available labor, capital, and technology.

• 3b.1 The concept of the aggregate production

function is used to relate real GDP to the inputs:

labor, capital, and technology. Because of this longterm relationship between inputs and output, any

slowdown in economic growth must be due to a

slowdown in the growth of one or more of the

inputs.



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Economic policies

• 3c. Policy for long-term economic growth

(sometimes called supply side policy) attempts to

increase potential GDP, or aggregate supply.

• Fiscal and monetary policy are other tools to

improve economy.



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Fiscal policy

• 3c.1 Fiscal policy can affect aggregate supply

through the use of tax changes or changes in

spending or borrowing. These incentives alter

labor, capital, and technology inputs to the

production function.



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Monetary policy



• 3c.2 Monetary policy is concerned primarily with

the control of the money supply in order to control

inflation. A low and stable rate of inflation is

desirable because it reduces the uncertainty

associated with determining prices and future

inflation when inflation is high or variable.



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25



Final thoughts

3d.1 Changes in aggregate demand are central to

the explanation of economic fluctuations, whether

due to fluctuations in business spending (Keynes)

or the money supply (monetarists).

3d.2 The potential of macroeconomic policy, both

fiscal and monetary, to alter the size of economic

fluctuations parallels the potential of policy to

affect economic growth. These details are pursued

in subsequent chapters.



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Figure 17.8 (Macro 4) The Ups and Downs in Interest Rates

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