Principles of Macroeconomics / Unit 8 MAC 0721 worked example, 60 to 90 seconds
Naming the Zone
The idea
Locate the economy by comparing output with potential, then read what a rightward demand shift would do. Far below potential, with idle workers and factories, the curve is flat: extra demand raises output with little effect on prices, and this is the zone Keynes described. At or near potential the curve is nearly vertical: extra demand mostly raises the price level, because there is little spare capacity, and this is the zone Say described. In between, extra demand raises output and prices together, and unemployment and inflation move in opposite directions.
In practice
Worked example: unemployment at ten percent with factories idle puts the economy in the flat zone, so a spending increase mostly raises output. Unemployment at the natural rate with capacity strained puts it in the steep zone, so the same spending increase mostly raises prices. Unemployment somewhat above the natural rate puts it between, so the increase splits between the two.
Where people slip
Economists disagree about where economies usually sit, and that disagreement is most of the difference between the schools in units nine and ten. The model itself does not settle it; it only says the answer depends on the zone.
Your place on the trail
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Builds on
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