Lecture Notes: Long Run Aggregate Supply, Short Run Aggregate Supply, and Aggregate Demand

Represents the economy's fixed capacity, or the maximum potential output with full employment.
Analogous to the production possibility curve, but at the scale of the entire economy.
The LAS curve represents the potential full employment level of output and production
Left of LAS: Inefficient; economy is underperforming with low productivity.
Right of LAS: Unattainable; economy is inflationary and unsustainable.
On the LAS line: Economy is at its potential and is efficient at the macro level.

Hard to pinpoint the exact location of the LAS due to data collection and GDP calculation issues.
Margins of error exist, represented by dotted lines, indicating a range where the LAS could be.
Equilibrium occurs where the long-run aggregate supply and short-run aggregate supply curves intersect.
Point C (to the right) represents an inflationary area.
Point A (to the left) represents a deflationary area, indicating underperformance.

General equilibrium of the economy: where the long-run aggregate supply (LAS) curve, short-run aggregate supply curve, and aggregate demand curve all intersect.
A shift in the aggregate demand curve can disrupt the equilibrium.
If aggregate demand shifts to the left, equilibrium could be below the natural equilibrium, indicating underperformance.
If aggregate demand shifts to the right, the equilibrium could be inflationary and unsustainable in the short term.
The goal is to bring the aggregate demand back to the point where all three curves intersect, ensuring long-term equilibrium.
If aggregate demand is not at equilibrium, policies are needed to shift it back to the equilibrium point.

Business cycles illustrate GDP fluctuations.
When the economy is in a downturn (recession), aggregate demand is on the left side of the LAS.
This indicates high unemployment and underproduction.
When the economy is in an inflationary period, aggregate demand is on the right side of the LAS.
The goal is to align aggregate demand with the LAS to stabilize the economy.

Factors that cause shifts in the aggregate demand curve, leading to changes in aggregate expenditure. These are macroeconomic equivalents to demand shifters at the microeconomic level.
Foreign income
Exchange rates
Distribution of incomes
Expectations (positive or negative)
Monetary and fiscal policy (focus of the lecture is fiscal policy)
Multiplier effects of each factor: initial action leads to multiple sequential actions in the economy.

If the economy is already at full employment (at its optimum level), stimulating the economy won't increase real output.
Additional stimulation will only lead to a general price increase, causing inflation.
When the economy is at full employment, policies should avoid increasing aggregate demand.

Aggregate Demand Zero indicates where the economy is currently.
Aggregate Demand 1 indicates where the economy will be after the policy.
When there are idle resources (human, capital), the economy can perform better by employing more people and increasing production.
The gap between current production and potential production is the deflationary gap.
Goal: shift the aggregate demand to the right to reach the equilibrium, increasing both employment and output.
Achieved through expansionary policies, where the government increases its expenditure (G) or cuts taxes.
Increased government expenditure: government funds projects (e.g., roads), employs people, and contracts companies, injecting money into the economy.
Tax cuts: leaves more money in the hands of the people, increasing their purchasing power and stimulating spending.
Examples: building infrastructure like the Golden Gate Bridge as a fiscal policy in the 1930s.
Both increased government expenditure and tax cuts are expansionary fiscal policies, shifting aggregate demand to the right.

Used when the economy faces inflationary pressures.
Y1 represents the economy's potential output, but currently, the economy is producing at Y0, which is higher than potential.
The goal is to reduce aggregate demand to bring output back to its potential level.
The gap between current output and potential output is the inflationary gap.
Tools: Contractionary fiscal policy involves reducing government expenditure (G) and increasing taxes.
Reducing government expenditure: cutting back on projects and contracts.
Increasing taxes: reducing the amount of money people have to spend, decreasing overall expenditure.

During crises, governments play a crucial role in solving problems when the private sector can't.
Finding the right balance between the private and public sectors is essential, depending on the situation.
Recession scenario: people lose jobs, reduce spending, and businesses face unsold products (surplus).
Aggregate demand decreases due to reduced consumption, investment, and exports.
Self-reinforcing mechanism: businesses reduce expenditures, leading to more unemployment and reduced consumption.

$Aggregate\ Demand = Consumption + Investment + Government\ Expenditure + (Exports - Imports)$

The government has to increase this to balance this back. This should be the role of government at a time of recession.

In a crisis, the government is the only entity capable of increasing aggregate expenditure.
Consumers and businesses are too scared to spend.
Government spending helps businesses sell products, increasing income and confidence.
This leads to further increases in expenditure by both businesses and consumers.

Japan: Increased expenditure by $1.1 trillion to keep businesses and households afloat.
The United States: Spent $2.2 trillion and considering additional trillions.
The European Union, China, and other countries are also implementing expansionary fiscal policies.

Expansionary fiscal policy: increase government expenditure and/or cut taxes to expand the economy during downturns.
Contractionary fiscal policy: decrease government expenditure and increase taxes to reduce inflation.