Aggregate Supply & Demand Model Part 2 Long Run AS Curves

Using AS/AD Model How can you improve the current economy? U.S. Economy AS1 Price Level Real GDP AD1 AD2 Gov’t ↓ Taxes => consumer income ↑ C ↑ => AD ↑ => R-GDP ↑ -------------------- ------------------ P2 Y2 E2 --------------- P1 Y1 E1 Opportunity Cost? Rising Gov’t Debt (risk of crowding out)

PPF Review Illustrates the full potential of an economy AS1 AD1 On PPF Line means: Unemployment low as possible (4.0%) Jobs match human capital Economy as efficient as possible AS1 Price Level Real GDP AD1 AS/AD Model -------------- P1 Q1 E1

Aggregate Supply Curves Short run curve (SRAS) is upward sloping Long Run curve (LRAS) is vertical at full potential output

Full Potential Output Level of Real GDP economy achieves in long run is based on a country’s full potential to produce goods/services What determines full potential?

Short Run Equilibrium In the short run an economy can be at, above, or below full potential In theory, in the long run => economy must be at full potential Full Potential Output Equilibrium On PPF Curve Unemployment low as possible Jobs match human capital Economy as efficient as possible

Full Potential Worksheet Long Run Equilibrium P1 ----------------- E1 Y1

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, idle resources Unemployment very low, output high Above PPF, no idle resources

How to produce more! As PPF shifts right => full potential ↑ => LRAS shifts right