INTRODUCTION

Three “rates” dominate discussions of macroeconomic issues: (1) the inflation rate, (2) the interest rate, and (3) the unemployment rate. In order to understand what can and cannot be done about them it is necessary to have at hand a model of the macroeconomy that can explain movements in these variables. Without the discipline of such a model it is easy to become confused by uninformed opinions and misleading observations. Only with such a model is it possible to comprehend why expanding the money supply is likely to increase the interest rate rather than decrease it, as is often suggested, and why it is virtually impossible to fulfill the politician's promise of “full” employment in a market-oriented economy.

The macroeconomic model to be presented in this chapter is not complicated. In fact, any student who has mastered an intermediate course in macroeconomics has learned the basic ingredients of the model. The IS-LM-AS curves are the only ones that will be used. The basic purpose of the model is to describe in a fairly general way the behavior observed in certain important markets in the economy. In microeconomics we are interested in markets for specific commodities, and the distinction between apples and oranges may be important in that context, but in macroeconomics we take a broader perspective where apples and oranges are just two of many commodities, all lumped together in one aggregate.