8 The Aggregate Market
10.1 macroeconomic perspectives on demand and supply
Some Facts about the Business Cycle
We are now going to begin to learn about the aggregate economy. That is, instead of looking at the supply and demand of a single good, we will begin to think about the supply and demand of everything in an economy. We will cover the basics in this chapter. The goal of learning this is to understand the impact that business cycles have on the macroeconomy and then what we can do to reduce the intensity of the business cycles. But, before we begin, it is important to think about the characteristics of a business cycle:
- Economic fluctuations are irregular meaning that they do not occur in a predictable fashion.
- Economic fluctuations vary in intensity.
- As output (real GDP) declines, other variables decline as well:
- Consumption
- Investment
- Orders for Durable Goods
- Residential Construction
- As output (real GDP) declines, other variables increase:
- Unemployment Rate
- Unemployment Insurance Payments
- Business Inventories (because goods were produced but not sold)
Note: This is a very short list. There are many other variables that are impacted as well. These are just the ones that will be most important to this class.
From: OpenStax Macroeconomics (http://cnx.org/content/col12190/1.4), Chapter 11.1
Say’s Law
Those economists who emphasize the role of supply in the macroeconomy often refer to the work of a famous early nineteenth century French economist named Jean-Baptiste Say (1767–1832). Say’s law is: “Supply creates its own demand.” As a matter of historical accuracy, it seems clear that Say never actually wrote down this law and that it oversimplifies his beliefs, but the law lives on as useful shorthand for summarizing a point of view.
The intuition behind Say’s law is that each time a good or service is produced and sold, it generates income that is earned for someone: a worker, a manager, an owner, or those who are workers, managers, and owners at firms that supply inputs along the chain of production. We alluded to this earlier in our discussion of the National Income approach to measuring GDP. The forces of supply and demand in individual markets will cause prices to rise and fall. The bottom line remains, however, that every sale represents income to someone, and so, Say’s law argues, a given value of supply must create an equivalent value of demand somewhere else in the economy. Because Jean-Baptiste Say, Adam Smith, and other economists writing around the turn of the nineteenth century who discussed this view were known as “classical” economists, modern economists who generally subscribe to the Say’s law view on the importance of supply for determining the size of the macroeconomy are called neoclassical economists.
If supply always creates exactly enough demand at the macroeconomic level, then (as Say himself recognized) it is hard to understand why periods of recession and high unemployment should ever occur. To b