In the previous chapters, we have discussed the short-run performance of the macroeconomy and the effects of monetary and fiscal policies in the short run. Now, we turn to the long run. This does not necessarily mean that we turn from monthly and quarterly time horizons to several years, although that is often the case. In the context of economic policies, short and long run are analytical concepts with no fixed analogy in time. The long run is the time horizon over which firms can vary all those things that lead to fixed costs in the short run, such as their stocks of capital, the location of their activities, and their production technologies. The long run is also the time horizon over which wages fully adjust to price level movements.

This chapter is all about a nation’s macroeconomy – it introduces the key concepts and indicators business managers, policymakers, and analysts look at and talk about when they describe the state of a nation’s economy and diagnose whether or not it is healthy, provides new business opportunities, or needs some policy intervention for improvement. To understand the macroeconomic environment you and your business operate in, you want to know the relevant terms, understand the concepts, and know what indicators to look at.

Macroeconomic policy debates tend to focus on aggregate demand. When output is considered too low or unemployment is rising, policymakers, the media, and the public call on the Fed to cut interest rates or on the federal government to provide stimulus. When inflation is going up, the Fed is told to put it under control. We want fast solutions and the way to get them is by managing aggregate demand. Therefore, most of this book is devoted to aggregate demand.

Economics is all about supply and demand. If the demand for Jack Daniel’s rises relative to supply, we predict that the price of Jack Daniel’s will rise and its quantity sold in the market will increase. Supply and demand, therefore, are common tools in the economist’s toolbox. This tool allows us to analyze why prices and quantities change and to think of both the reasons for these changes and what policies might be used to combat them if deemed necessary.

A country’s economy is continually buffeted by shocks to aggregate demand and aggregate supply. AD shocks come from households, firms, governments, and foreign buyers. They change their spending patterns because the causal variables discussed in Chapter 3 change and impact them. These changes in aggregate demand are often large and persistent enough to become the subject of economic policy. Should governments intervene in the economy and attempt to bring aggregate demand back to a normal and sustainable level, or one that the government deems more appropriate? If so, monetary and fiscal policies are often used to stabilize AD changes.

Fiscal policy refers to the government’s use of taxation, spending, and regulatory policies to achieve its economic and political goals. As with monetary policy, there are many issues and controversies that relate to the use of fiscal policy. Since these issues and controversies play out in the political arena daily, business planners need to pay attention, because the results will come to affect them. Fiscal policies of the past and expected policies of the future can have pronounced impacts on interest rates, spending, profits, exchange rates, and many other aspects of the business environment. This chapter develops the basic terminology, concepts, and theories that relate to fiscal policy. It explains how fiscal policy affects aggregate demand and how the government can use it to counteract business-cycle fluctuation.

In the new world of international trade, the playing field is hardly level. The richer countries have relatively low trade barriers for most goods and commerce, but cling to protection for selected sectors of the economy, especially their farmers, services, and their airlines. These countries enjoy the trade advantages of having high-quality transportation and communication networks, the best technology, and the most educated workers. Developing countries, in contrast, seek to achieve equality in infrastructure, capital, and labor, but know it will take decades to catch up. In the meantime, they also feel the need to protect many of their young industries from the full force of the industrial nations, while demanding access to the markets of those countries for their agricultural and food products.