in this chapter we will explore:
- 5.1 Aggregate demand and aggregate supply
- 5.2 Equilibrium output and potential output
- 5.3 Growth in a potential output
- 5.4 Business cycles and output gaps
- 5.5 Output gaps and unemployment
- 5.6 Adjustments to output gaps?
- 5.7 The role of macroeconomic policy
Macroeconomic analysis has important time dimensions. In the long run, over periods of several years and decades, real GDP in most industrial economies grows and per capita real GDP grows as well, raising standards of living. We have seen the data for Canada on this long-run performance in Chapter 4. We have also seen that growth rates fluctuate over short time periods of a few months or a few years. At some times real output declines and at other times it grows very rapidly. Economists describe these short-run fluctuations as business cycles, using the words recession, recovery, boom, and slump to describe different stages of the business cycle. These words are also part of the everyday language of the news media, which often engages in a debate over current economic conditions as they foretell continuing stability, a recession, or recovery from a recession. The financial crises and recession of 2008–2009 and ongoing public debt and unemployment problems in Europe and North America are the most recent examples.
An aggregate demand and aggregate supply model is the workhorse of macroeconomics. It illustrates the determination of real GDP and the GDP deflator, and changes in those measures of output and prices. In this chapter we introduce a basic aggregate demand and supply model and use it to illustrate the causes and effects of business cycle fluctuations in real output and prices. This provides the framework for most of what comes later, the development of the economic theory on which aggregate demand and supply are based.