Macroeconomics the Ad-As Model Explains How Full

Macroeconomics The AD-AS model explains how full employment can be reached from a situation of deep recession, assuming no fiscal policy stimulus. The underlying assumption of this theory is that when the economy improves, that this will have an impact on employment. The model therefore assumes a pre-globalization world where increases in aggregate supply on the part of companies in the U.S. will actually be made by U.S. workers.

The thesis statement for this paper is that technological innovation is the most likely means by which the economy can return to full employment under the circumstances described. In this situation, without fiscal stimulus, the economy is not going to see any increase in aggregate demand because of persistent high unemployment and likely fears about the state of the economy. Businesses are likely to begin this recession with excess capacity, keeping them from making investments as well.

However, the economy will still be functioning -- it will only be below its capacity level. Over time, technological improvements will increase the aggregate supply. This can occur either through major new technological innovation -- the development of the Internet is cited -- that shifts the AS curve to the right quickly. Or, these changes can occur gradually, which seems to be the case most of the time, with incremental improvements in technology and efficiency increasing productivity and stimulating new consumer demand.

Such improvements will encourage business investment as well, either because projects are more profitable, or because new products are spurring new demand. An example of the latter would be the smartphone business, which emerged in the depths of the recession but did not lack for demand. Again, the assumption is that over time new technologies and production efficiency will spur a growth in employment. Even with offshoring of jobs, some new employment is to be created.

For example Apple took some profits from the iPhone and created the iPad, and now it is returning cash to shareholders, who will then spend or invest it elsewhere. Either way, there are going to be some positive employment effects as a result of this rightward shift in the aggregate supply curve. Another theory is that if prices and wages are flexible the economy can move back to full employment. The idea is that if prices and wages have downward flexibility, the economy can move back to full employment.

With lower prices and wages, producers will have lower production costs. They will then produce more, shifting the short-run aggregate supply curve to the right. The question is why would they produce more, if the recessionary gap is caused by a slump in demand? If demand is slumping, lower prices is not going to help that, when lower prices are matched by lower wages. Prices need to be more flexible than wages. Fortunately this is likely true -- wages are not very flexible, so prices likely are more flexible.

However, this self-correcting mechanism could rely on those lower costs for producers allowing them to sell their products overseas, where new demand.