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Explain (using graphs as appropriate) the response of output, employment, and the price level to an aggregate demand or aggregate supply shock in the long run.

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Economists use the aggregate demand–aggregate supply model to represent the relationship between the price level and aggregate output in an economy and to illustrate how output, employment, and the price level respond to macroeconomic shocks.

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In the long run, in the absence of government policy actions, flexible wages and prices will adjust to restore full employment and unemployment will revert to its natural rate after a shock to aggregate demand or short-run aggregate supply.

Shifts in the long-run aggregate supply curve indicate changes in the full-employment level of output and economic growth.

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subscribe to The Indicator from Planet Money podcast

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Most people think of economics as a science driven by data and trends. But the economy has an irrational underlying force: "animal spirits."

The term animal spirits was coined - in reference to economics - back in 1936 by John Maynard Keynes. Keynes used it to describe the way people's emotional decisions can sway the markets.

Today on The Indicator, we speak to Robert Shiller, Nobel Prize winner in economics and co-author of the book Animal Spirits. He helps us understand why animal spirits are important to keep in mind in today's economy.

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subscribe to The Indicator from Planet Money podcast subscribe to The Indicator from Planet Money podcast Most people think of economics as a science driven by data and trends. But the economy has an irrational underlying force: "animal spirits." The term animal spirits was coined - in reference to economics - back in 1936 by John Maynard Keynes.

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One point of contention among economists is the causes of business cycles and recessions. And if you disagree on the causes, chances are that you disagree on the solutions.

In this video series, we're going to explore some of the major business cycle theories - Keynesian, Monetarist, Real Business Cycle, and Austrian - and what their proponents think we ought to do about recessions. In the final video, we'll take a look at how all four can be applied to the recent Great Recession.

First up, let's explore the Keynesian theory. Keynesian economics is so named after British economist John Maynard Keynes (1883-1946). Keynes is well-known for his treatise The General Theory of Employment, Interest, and Money, which helped shaped modern macroeconomics. The key component of the Keynesian theory is aggregate demand and the assumption that nominal wages are sticky.

Recessions are unpleasant experiences. We all want to get out of them as quickly as possible. So what would a Keynesian do?

Keynesians tend to favor activist fiscal policy and monetary policy. In other words, they want governments to spend more (think deficits and public works programs) and grow the money supply while lowering interest rates. The idea is that the government is doing everything it can to stimulate aggregate demand.

We'll cover some problems associated with Keynesian theory in this video, too, and take a deeper dive into the AD-AS model.

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Game of Theories: The Keynesians | Macroeconomics Videos

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One point of contention among economists is the causes of business cycles and recessions. And if you disagree on the causes, chances are that you disagree on the solutions. In this video series, we're going to explore some of the major business cycle theories - Keynesian, Monetarist, Real Business Cycle, and Austrian - and what their proponents think we ought to do about recessions.

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Game of Theories: The Monetarists | Macroeconomics Videos

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Meet the monetarists! This business cycle theory, formulated by Nobel Laureate Milton Friedman, emphasizes the effect of the money supply and the central bank on the economy.

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So far in our business cycles deep dive, we've covered two of the four main theories: Keynesian and monetarist. Now, we're going to move away from aggregate demand and monetary policy to check out the supply side of things in real business cycle (RBC) theory.

In RBC, the "real" part refers to real shocks to an economy. Specifically, it refers to supply shocks.

Think about what might happen if the price for oil suddenly increased dramatically. We rely on oil a ton. Not only is oil crucial for travel, but also for the production of many everyday goods. That steep price increase would be a negative supply shock and put a damper on many sectors of the U.S. economy. A recession could follow.

This is exactly what happened in the U.S. in 1973 when the price of oil quadrupled for American buyers.

Okay, so RBC is useful for a complex supply shock. But it can also explain many of the economic downturns throughout human history. For instance, in ancient times when economies relied primarily on agriculture, a drought would be truly awful for the economy. It's a much simpler example, but it's still a negative supply shock.

What are the solutions to a downturn in RBC? Basically, try to avoid over-reliance on the supply of any particular good. In the case of an oil shock, be prepared by investing in alternative energy solutions. And try to make your economy flexible so that it can quickly respond to a negative real supply shock and limit the cost.

Like the theories we've discussed in previous videos, there are limitations to what RBC can explain. For instance, it's not as useful in explaining recessions that are caused by monetary policy, banking, and credit in a modern economy. Check out our video for more on where RBC can, and can't, shed light.

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Game of Theories: Real Business Cycle | Macroeconomics Videos

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So far in our business cycles deep dive, we've covered two of the four main theories: Keynesian and monetarist. Now, we're going to move away from aggregate demand and monetary policy to check out the supply side of things in real business cycle (RBC) theory.

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The Austrian school of economic thought emphasizes market price signals and how they communicate decentralized information in an economy. The Austrian business cycle theory focuses on how central banks can distort those price signals.

When central banks increase the money supply, inflation goes up. This pushes market interest rates down and credit becomes easier to obtain. According to the Austrians, the market has been distorted in this scenario by central bank interference.

Now imagine you're an entrepreneur. Interest rates are around 5%. There are a lot of investments that would be appealing to you if interest rates were just a little lower. Now let's say that, due to an increase in the money supply, interest rates drop to 1% and you make your investments.

According Austrian business cycle theory, these investments only seem more profitable because the market price signal has been distorted. But many entrepreneurs like yourself will have invested in building more homes, factories, etc. It will turn out that the demand for those homes and factories wasn't actually that high. Investments will be liquidated. Workers will be laid off. So we have a boom full of malinvestment, followed by a bust.

Interest rates can lower through market forces, but it's a result of consumer saving - not the central bank's actions. So under "normal" circumstances, the lower interest rates would be a signal to entrepreneurs that it's a good time to invest in these projects. The problem, according to the Austrians, is that consumers haven't been saving more when interest rates lower from the central bank interference. The demand isn't there because savings in the economy are insufficient.

Where does the Austrian business cycle theory fall short? It doesn't explain how so many entrepreneurs are tricked by the central bank. It also doesn't really deal with why busts are so painful. It may have to borrow from other theories (e.g., monetarist or Keynesian) to deal with the high unemployment we see during recessions. It also implies that consumption and investment move in opposite directions. However, the data shows that they tend to move together.

Austrian business cycle theory does explain some features of booms and busts, but it remains to be seen whether it can be a more fundamental explanation.

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Game of Theories: The Austrians | Macroeconomics Videos

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The Austrian school of economic thought emphasizes market price signals and how they communicate decentralized information in an economy. The Austrian business cycle theory focuses on how central banks can distort those price signals. When central banks increase the money supply, inflation goes up. This pushes market interest rates down and credit becomes easier to obtain.

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There's an old analogy about blind men grasping an elephant. Elephants are huge creatures. If you're touching the trunk, but you can't see the whole elephant, you'

There's an old analogy about blind men grasping an elephant.

Elephants are huge creatures. If you're touching the trunk, but you can't see the whole elephant, you're going to have a very different perspective from someone touching a leg. It doesn't mean that either of you are wrong in your perspective; you're just focused on different parts of the whole.

You can use this analogy when thinking about the business cycle theories we've explored in recent videos and how they can be applied to economic downturns. To grasp the elephant that is the Great Recession, for instance, we'd need to take into account these different perspectives.

In Game of Theories, we've covered the basics of what proponents of Keynesian, monetarist, real business cycle, and Austrian theories think about why economies go through booms and bust. We've also dealt with some of the shortcomings of each.

Now let's turn to how they might explain a recent historical example: the Great Recession of 2008.

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Game of Theories: The Great Recession | Macroeconomics Videos

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There's an old analogy about blind men grasping an elephant. Elephants are huge creatures. If you're touching the trunk, but you can't see the whole elephant, you' There's an old analogy about blind men grasping an elephant. Elephants are huge creatures.

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1. Can you describe what causes SRAS to shift toward long-run equilibrium in the absence of government involvement?

2. What were Keynes’ criticisms of the Classical theory?

3. What does Keynes focus on in moving an economy in disequilibrium toward long-run equilibrium?

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Fear the Boom and Bust: Keynes vs. Hayek - The Original Economics Rap Battle!

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"Fight of the Century": Keynes vs. Hayek Rap Battle Round Two

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Subscribe to our channel: http://www.youtube.com/user/econstories If you enjoyed this video, you should watch this one next: http://youtu.be/Mq2iQAsJAhI Produced by Emergent Order. Visit us at http://emergentorder.com. "Fight of the Century" is the new economics hip-hop music video by John Papola and Russ Roberts at http://EconStories.tv.

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Store photos and docs online. Access them from any PC, Mac or phone. Create and work together on Word, Excel or PowerPoint documents.

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In Macroeconomics, Demand Side Policies are attempts to increase or decrease aggregate demand in order to affect output, employment and inflation.Demand Side Policies can be classified into fiscal policy and monetary policy.

In general, demand side policies aim to change the aggregate demand in the economy. Aggregate Demand is made up of Consumer Spending + Government Spending + Investment + Net Exports (exports - imports). So anything that effects these factors will affect demand. We tend to use demand side policies for short term changes - if inflation is getting too high, we can increase interest rates to cool the economy down.

Demand-side policies may be expansionary or contractionary in nature. Expansionary policies are intended to stimulate spending in a recessionary economy; contractionary policies intended to reduce spending in an inflationary economy.

On the other hand, policymakers also have the option of using Supply Side Policies. These policies are aimed at increasing Aggregate Supply (AS), a shift from left to right. Successful supply side policies lower the natural rate of unemployment.

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Demand Side Policies | Intelligent Economist

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In Macroeconomics, Demand Side Policies are attempts to increase or decrease aggregate demand in order to affect output, employment and inflation.Demand Side Policies can be classified into fiscal policy and monetary policy. In general, demand side policies aim to change the aggregate demand in the economy.