Macroeconomic Theories
AP Macroeconomics
Where did we come from?
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The “levers”:
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In the previous lesson
we learned about the
levers of economic
growth, and how the
government can
stimulate these levers.
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Ways to stimulate these
levers:
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http://www.extirpated.org/3.html
1) The supply of labor
2) The supply of capital
3) The supply of
technology
1) Savings
2) Research
3) International Trade
4) Education/training
Where are we going?
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In this lesson, we’ll
discuss the current
issues and sources of
disagreement among
economists.
Most economists hold
views that cannot be
categorized into a
particular school of
thought.
In this lesson…
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We will discuss the lags associated with
policy-making.
What is a lag?
What are the lags in policy making?
• Inside lag
• Outside lag
• Recognition lag
• Decision (or response) lag
• Transmission (or impact) lag
Defining the “Inside Lag”
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The inside lag consists of the time it take
for the following to occur:
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Data to be collected
Policy makers to recognize that policy
action is necessary
Policy makers to make the decision about
which policy should be taken, and the
implementation of that policy
Defining the “Outside Lag”…
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The outside lag is the time it takes the
economy to respond to a new policy.
Defining the “Recognition Lag”…
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The recognition lag is the time it
takes for policy makers to see that
there is a problem with the
economy. In general, this is 3-6
months.
Defining the “Decision (response) Lag”…
The decision (or response) lag the
times it takes for policy makers to
decide and implement the policy
response to the current economic
problem.
 This is part of the inside lag!
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Defining the “Transmission (or impact)
Lag”…
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The transmission (or impact) lag is the
time it takes the change in policy to
actually have an effect of the economy.
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This lag is very short for fiscal policy because of
the media—by the time it is implemented,
people are ready to adjust.
This lag is long for monetary policy because the
change in the MS affects interest rates, which
affect interest-rate sensitive components of AD.
Recognize  Decide  Transmit
Where do these fit?
Outside lag
Inside lag
Outside Lag
Inside lag
Recognize
Decide
Transmit
Impact of government borrowing to
finance increases in government
expenditure, aka crowding out!
Visual 5.3 Unit 5 Macroeconomics
Why don’t prices & wages adjust quickly?
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First, take a guess…
Next, let’s discuss…
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Menu Costs: it costs firms money to change their prices—
for example, to issue new catalogs or change price tags.
Labor contracts: multiyear contracts prohibit rapid
changes in wages and may mandate cost-of-living
adjustments (increases to match inflation).
Firms worry about changes prices and getting into price
wars with their competitors. Hence, firms might delay
adjusting prices to changes in costs or demand.
Let’s Review…
• Initially the economy is at Y*, potential GDP
and P.
Aggregate demand increases from AD to AD1
and the economy moves to Y1 and P1.
The final equilibrium is Y* and P2.
•If the economy is already
at full employment but
policy makers think the
unemployment rate is too
high and carry out
expansionary monetary
policy, inflation will result.
• This demonstrates the
conflict between the fullemployment goal and the
price stability goal.
Visual 3.13 Unit 3 Macroeconomics
And now…
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Some resources:
Reffonomics:
http://www.reffonomics.com/
Morton workbook: Activity 48
Krugman: Module 36
Works Cited
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Economics of Seinfeld.
http://yadayadayadaecon.com/
Krugman, Paul, and Robin Wells. Krugman’s
Economics for AP. New York: Worth
Publishers.
Morton, John S. and Rae Jean B. Goodman.
Advanced Placement Economics: Teacher
Resource Manual. 3rd ed. New York: National
Council on Economic Education, 2003. Print.
Reffonomics. www.reffonomics.com.