No Free Lunch: Economics for a Fallen World: Third Edition, Revised

Chapter Eighteen: The “macro” view of the economy 453 of GDP, yet a Honda built in Japan and sold in the U.S. must be subtracted from GDP. Finally, GDP is a stock variable, not a flow variable, which means that it is calculated at a specific period of time. In the U.S., GDP is calculated quarterly as well as annually. The number released in a given quarter is reported in an annual percentage number. For example, if GDP rises by 1% in a quarter, it will be reported as 4% economic growth that quarter. This concludes our review of thinking about economic activity from a consumption perspective; in the next section we’ll examine economic activity from a production viewpoint. AGGREGATE SUPPLY In the previous section, we said we could think about aggregate demand as being the total spending in an economy, or the total income of all the market participants, since one person’s spending is necessarily someone else’s income. Yet income primarily comes about from the sale of goods and services, which leads us to another way of thinking about economic activity: the supply side. In chapter 7 we identified the production function as a way to think about any productive activity, and we used a simple model where the quantity (Q) of output was a function of the labor (L) and capital (K): Q = f (L,K) In chapter 9, we expanded this to a more robust model which included technological change, entrepreneurship, human capital, and natural resources: Q = A f ( L, K, H, N ) We can think of the sum of all the production activities in the economy as Aggregate Supply (AS) and the production inputs as the sum of all resource inputs available in the economy): AS = A f(L, K, H, N) = Y Even if the relationship is not something we can direct—as if the economy were one large firm—we nevertheless understand that increasing the supply of productive resource inputs can potentially lead to higher economic output. Economists that focus on the supply side often propose government policies that encourage people to work, save, and invest. In other words, “supply-siders” primarily (but not exclusively) advocate for adjusting incentives for private sector activities. For example, a low tax rate on labor or capital will tend to result in an increased supply of those resource inputs. Likewise, political support for drilling for energy on public lands effectively increases the amount Aggregate supply: the sum of all the production activities in the economy