Aggregate Equilibrium Macroeconomic Theory

Inflationary Gap Recessionary Gap Economy above full output Economy below full output LRAS1 Price Level Real GDP SRAS1 LRAS1 Price Level Real GDP SRAS1 AD1 AD1 P1 Y1 ----------------- -------------- E1 P1 Y1 ----------- --------- E1 Y* Y* Unemployment high, real output low Below PPF, Actual Px level < Expected Unemployment very low, output high Above PPF, Actual Px level > Expected

Note: you are graphing actual price level Short Run Equilibrium In short run, a shift in AD will cause changes in real GDP, Unemployment & price level Reason: Prices & Wages are sticky expected price level LAGS actual price level This allows recessionary & inflationary gaps Note: you are graphing actual price level

Long Run Equilibrium In long run, AD shifts do not affect real output (or employment) Prices/wages become perfectly flexible in long run Actual price level must equal expected price level Will always be at full potential output (full employment)

LONG RUN EQUILIBRIUM IN A LONG RUN EQUILIBRIUM: 3 Things must be true: 1) Expected Price Level = Actual Price Level 2) Employment = Full Employment 3) Real GDP = Full Potential Output (on PPF) Quantity = Natural rate + a( Actual Px - Expected Px) Supplied of Output ( Level Level ) Equation from Textbook (you do not need to understand this….)

Manipulating AD/AS Worksheet

Example: Stock Market Crash 2- causes output to fall in short run . . . Short run —Step 1 & 2 Price Long Run– Step 3 & 4 Level LRAS SRAS1 AD1 SRAS2 AD2 3. . . . but over time, SRAS shifts as expected Price level falls . . A P Y B P2 Y2 1-Decrease in AD C P3 4. . . . and output returns to its natural rate. . Real GDP