focus of the chapter
• We begin our study of macroeconomics with an introduction to the three models around which it is organized and the time horizons to which they apply. We also take a preliminary look at economic growth, inflation, unemployment, and the business cycle, and provide an overview of the textbook.
1. Macroeconomics Encapsulated in Three Models
Almost everything you will learn about macroeconomics can be understood in the context of three models: growth theory, which describes the behavior of the economy in the very long run when capital, labor, and technology can all vary, and the aggregate supply-aggregate demand
(AS-AD) model, which describes the behavior of the economy at all shorter horizons. This is really a combination of two different models: one of aggregate supply, another of aggregate demand. Different assumptions about aggregate supply determine the time horizon over which the model applies.
It is useful to have some working definitions of the time frames we’re talking about. The “very long run,” the domain of growth theory, refers to periods of decades or more, during which all of the inputs to productioncapital, labor, the level of technology and size of the populationcan change. We look at the behavior of potential rather than actual output over this period; we watch the amount of output that would be produced, if all inputs to production were fully employed.
The terms “long”, “medium” and “short” run refer to periods of time during which the supplies of capital, labor, etc. are fixed, or during which the level of potential output is constant. The main difference between these time periods is whether we assume these inputs are fully employed: in
the long run we assume that they have to be, so that output equals potential output; at shorter horizons, we let them be either over- or underemployed and look at the resulting output gap.