Capitulo 14 - Mankiw

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CHAPTER

14

A Dynamic Model of Aggregate
Demand and Aggregate Supply
The important thing in science is not so much to obtain new facts as to discover
new ways of thinking about them.
William Bragg

T

his chapter continues our analysis of short-run economic fluctuations. It
presents a model that we will call the dynamicmodel of aggregate demand and
aggregate supply. This model offers another lens through which to view the
business cycle and the effects of monetary and fiscal policy.
As the name suggests, this new model emphasizes the dynamic nature of
economic fluctuations. The dictionary defines the word “dynamic” as “relating to energy or objects in motion, characterized by continuous change or
activity.”This definition applies readily to economic activity. The economy is
continually bombarded by various shocks. These shocks have an immediate
impact on the economy’s short-run equilibrium, and they also affect the subsequent path of output, inflation, and many other variables. The dynamic
AD –AS model focuses attention on how output and inflation respond over
time to exogenous changes in theeconomic environment.
In addition to placing greater emphasis on dynamics, the model differs from
our previous models in another significant way: it explicitly incorporates the
response of monetary policy to economic conditions. In previous chapters, we
followed the conventional simplification that the central bank sets the money
supply, which in turn is one determinant of the equilibriuminterest rate. In the
real world, however, many central banks set a target for the interest rate and
allow the money supply to adjust to whatever level is necessary to achieve that
target. Moreover, the target interest rate set by the central bank depends on economic conditions, including both inflation and output. The dynamic AD–AS
model builds in these realistic features of monetary policy.Although the dynamic AD –AS model is new to the reader, most of its
components are not. Many of the building blocks of this model will be familiar from previous chapters, even though they sometimes take on slightly different forms. More important, these components are assembled in new ways.
You can think of this model as a new recipe that mixes familiar ingredients to
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PART

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Business Cycle Theory: The Economy in the Short Run

create a surprisingly original meal. In this case, we will mix familiar economic relationships in a new way to produce deeper insights into the nature of
short-run economic fluctuations.
Compared to the models in preceding chapters, the dynamic AD–AS model
is closer to those studied byeconomists at the research frontier. Moreover, economists involved in setting macroeconomic policy, including those working in
central banks around the world, often use versions of this model when analyzing
the impact of economic events on output and inflation.

14-1

Elements of the Model

Before examining the components of the dynamic AD–AS model, we need to
introduce one piece ofnotation: Throughout this chapter, the subscript t on a
variable represents time. For example, Y is used to represent total output and
national income, as it has been throughout this book. But now it takes the form
Yt, which represents national income in time period t. Similarly, Yt −1 represents
national income in period t − 1, and Yt +1 represents national income in period
t + 1. This newnotation will allow us to keep track of variables as they change
over time.
Let’s now look at the five equations that make up the dynamic AD–AS model.

Output: The Demand for Goods and Services
The demand for goods and services is given by the equation
−
Yt = Yt – (rt – r) + t,
a
e
−
where Yt is the total output of goods and services, Yt is the economy’s natural
level of output, rt is the...