Short & long run macroeconomic equilibrium

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Intros
Lessons
  1. Short Run Macroeconomic Equilibrium
    • Intersection of AS and AD curve
    • Real GDP demand = Real GDP supplied
    • Price level above Equilibrium
    • Price level below Equilibrium
  2. Long Run Macroeconomic Equilibrium
    • Long-run Aggregate Supply
    • Full Employment
    • Price level above Long-run Equilibrium
    • Price level below Long-run Equilibrium
  3. Economic Growth & Inflation with AS-AD Model
    • AD Curve shifts Right
    • LAS Curve shifts Right
    • Inflation growth Rate
    • GDP Growth Rate
  4. Business Cycle with AS-AD Model
    • No Output gap   \,   \, full employment
    • Inflationary gap   \,   \, above full employment
    • Recessionary gap  \,   \, below full employment
Topic Notes
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Short Run Macroeconomic Equilibrium

The short-run macroeconomic equilibrium happens when

SASq=ADqSAS_{q} = AD_{q}


Where:
ADqAD_{q}   \,   \, quantity of real GDP demanded
SASqSAS_{q}   \,   \, quantity of real GDP supplied in the short run

Graphically, this happens when the short-run aggregate supply and aggregate demand intersects

Short & Long Run Macroeconomic Equilibrium


The intersection gives us the price level.

If the price level is not at the equilibrium, then there are two possible cases.

Case 1: The price level is above the short-run equilibrium price level.

Short & Long Run Macroeconomic Equilibrium


In this case, the firms are not able to sell all their outputs due to the excess in supply. Since remaining outputs get stockpiled, firms would eventually have to cut production until all their output is sold. Eventually, we go back to the equilibrium.

Case 2: The price level is below the short-run equilibrium price level.

Short & Long Run Macroeconomic Equilibrium


In this case, the firms are not able to meet the demand due to the shortage of outputs. The firms would have to increase production and costs to meet the demand of outputs they need. Eventually, we go back to the equilibrium.

Note: Recall that in the short run, money wage rate is fixed so it is possible that real GDP is greater or less than potential GDP.

Long Run Macroeconomic Equilibrium

The long-run macroeconomic equilibrium happens when potential GDP is equal to real GDP, and full employment is reached (unemployment rate = natural rate of unemployment). Equivalently, it happens when

SASq=ADq=LASqSAS_{q} = AD_{q} =LAS_{q}


Where:
ADq AD_{q} \,   \, quantity of real GDP demanded
SASq SAS_{q} \,   \, quantity of real GDP supplied in the short run
LASq LAS_{q} \,   \, quantity of real GDP supplied in the long run

Graphically, this is when the short-run aggregate supply, long-run aggregate supply, and aggregate demand all intersect.

Short & Long Run Macroeconomic Equilibrium


What if the price level is currently not at the long-run macroeconomic equilibrium? The idea is that eventually the price level will always go the long-run equilibrium price level.

Let’s look at 2 cases.

Case 1: The short-run equilibrium price level is above the long-run equilibrium price level.

Short & Long Run Macroeconomic Equilibrium


The money wage rate is very high, and unemployment rate > natural rate of unemployment. High money wage rate causes workers to supply more labor. So SAS0 SAS_{0} shifts right, becoming SAS1 SAS_{1} , and the price level is now at the long-run equilibrium price level.

Case 2: The short-run equilibrium price level is below the long-run equilibrium price level.

Short & Long Run Macroeconomic Equilibrium


The money wage rate is very low, and unemployment rate < natural rate of unemployment. Low money wage rate causes workers to supply less labor. So SAS0 SAS_{0} shifts left, becoming SAS1 SAS_{1} , and the price level is now at the long-run equilibrium price level.

Economic Growth & Inflation with AS-AD Model

Economic Growth & Inflation: When potential GDP increases from labor productivity and growth of labor, the LAS curve shifts to right. Inflation in the economy causes the AD curve to shift to the right.

There are 3 types of ways the AD curve and LAS curve can shift.

Case 1: Inflation growth rate > GDP growth rate. So, the AD curve shifts more than the LAS curve, causing an increase in the price level.

Short & Long Run Macroeconomic Equilibrium


This results in an inflation to the price level.

Case 2: Inflation growth rate = GDP growth rate. So, the AD curve shifts the same amount as the LAS curve, causing neither an increase nor decrease to the price level.

Short & Long Run Macroeconomic Equilibrium


This results in no changes to the price level.

Case 3: Inflation growth rate < GDP growth rate. So, the AD curve shifts less than the LAS curve, causing a decrease in the price level.

Short & Long Run Macroeconomic Equilibrium


This results in a deflation to the price level.

Business Cycle with AS-AD Model

Recall that the output gap is the difference between real GDP and potential GDP. An output gap can either be inflationary or recessionary.

Case 1: When real GDP = potential GDP, there is an no output gap. The AS curve and AD curve intersects on the LAS curve.

Short & Long Run Macroeconomic Equilibrium


We achieve full-employment equilibrium (unemployment rate = natural rate of unemployment).

Case 2: When real GDP > potential GDP, there is an inflationary gap. The AS curve and AD curve intersects at the right of the LAS curve.

Short & Long Run Macroeconomic Equilibrium


We achieve above full-employment equilibrium (unemployment rate < natural rate of unemployment).

Case 3: When real GDP < potential GDP, there is a recessionary gap. The AS curve and AD curve intersects at the left of the LAS curve.

Short & Long Run Macroeconomic Equilibrium


We achieve below full-employment equilibrium (unemployment rate > natural rate of unemployment).