Aggregate Demand and Aggregate Supply - The AD-AS Model - Long Run Macroeconomic Equilibrium
7 important questions on Aggregate Demand and Aggregate Supply - The AD-AS Model - Long Run Macroeconomic Equilibrium
What do we call I when the point of short run equilibrium AD and short run equilibrium AS is on the long run aggregate supply curve? And describe what it is?
- We call it the Long run macroeconomic equilibrium
- it is the intersection of all three curves the LRAS, SRAS, and, AD
- short run equilibrium is equal to potential output
What happens when there is a sudden worsening of business, and bad consumer expectations? What gap do we call this event? And what does it mean?
- The aggregate demand falls, and shifts leftward
- this leads to a lower equilibrium aggregate price level at and a lower equilibrium aggregate price level
- so it settles at the short run equilibrium E2
- but this point is below output so the economy is facing a recessionary gap
- recessionary gap occurs when there is high unemployment
What happens during a recessionary gap? What happens to
- The economy face high unemployment,
- nominal wages fall
- producers then increase output, because of reduced costs
- leading to a shift of the SRAS curve to shift to the right until the economy get back to E3 or the long run equilibrium
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What happens when there is a sudden improvement of business, and good consumer expectations? What gap do we call this event? And what does it mean?
- There will be an increase in aggregate demand
- initially we have the short run aggregate supply curve that is at the LR macroeconomic equilibrium
- now the AD rises and the AD curve shifts to the right
- leading to a higher aggregate price level and a higher aggregate output level
- the new short run aggregate output is now above the potential output
- now unemployment is low and the price level is high, so there is an inflationary Gap
What happens after an inflationary gap?
- As there is low unemployment, nominal wages will rise as will other sticky prices.
- the inflationary gap causes the short run aggregate supply curve to shift gradually to the left as producers reduce output, because of higher nominal wages
- bringing the economy through leftward shifts of the SRAS curve to a new position where AD= AS=LRAS where all three intersect at E3
- at E3 the economy is back in the Long run macroeconomic equilibrium
What is the tool used to determine how the economy responds recessionary and inflationary gaps. And how do we describe it? And what is the formula? Where does this tool always tend to go back to?
the output Gao is the difference between actual aggregate output and potential output
(actual aggregate output - potential aggregate output)/ potential output)*100
the output gap always tends to go back towards zero
What do we call the process in the long run that makes the output gap always zero? So what can we say about output in the short run and in the long run?
- We say the economy is self correcting
- because shocks tp the aggregate demand affects the aggregate output in the short run but not in the long run
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