Equilibrium By J.A. SACCO

AS>AD Equilibrium Recall- Intersection of demand and supply * More complicated because of the two aggregate supply curves- but the concept is the same If the price level – Excess quantity of real goods/services. AS>AD Result is suppliers drop the price which will create greater quantity of aggregate demand

Equilibrium SRAS LRAS AD 140 At price level 140 AS>AD and the price level falls. Price Level 120 100 1 2 3 4 5 6 7 8 9 10 Real GDP per Year ($ trillions)

AD>AS Equilibrium Result is because of the shortage If the price level -Quantity of AD would be greater than quantity of AS. Result is because of the shortage buyers will bid up price which will result in suppliers increasing the quantity supplied. AD>AS

Equilibrium SRAS LRAS AD 140 At price level 100 AD>AS and the price level increases. Price Level 120 100 1 2 3 4 5 6 7 8 9 10 Real GDP per Year ($ trillions)

Equilibrium SRAS LRAS AD 140 At price level 120 AD=AS. Price Level 120 100 1 2 3 4 5 6 7 8 9 10 Real GDP per Year ($ trillions)

Two Types of Equilibrium What is the state of the economy in the model to the right? What is meant by long run equilibrium? Draw an example? What is meant by short run equilibrium? Draw an example? Which equilibrium is most important? If the economy is at full equilibrium, this doesn’t mean the economy will stay there . Economic “shocks” occur that may shift the curves.

Consequences of Changes in Aggregate Supply and Demand Shift in curves. The effect is the price level or real GDP may change or both. Gives insight into inflation or recessions. Aggregate Demand Shock Any shock that causes the aggregate demand curve to shift inward or outward. Aggregate Supply Shock Any shock that causes the aggregate supply curve to shift inward or outward. How does this effect the economy?

Consequences of Changes in Aggregate Supply and Demand Contractionary Gap/Recessionary Gap Exist whenever the equilibrium level of real national income is less than the full-employment level

The Effects of Stable Aggregate Supply and a Decrease in Aggregate Demand: The Contractionary Gap SRAS 7 LRAS AD1 AD2 6.5 Price Level 120 E1 E2 6.8 Contractionary Gap 115 Real GDP per Year ($ trillions)

Consequences of Changes in Aggregate Supply and Demand Expansionary Gap/Inflationary Gap Exist whenever the equilibrium level of real national income is greater than the full- employment level

The Effects of Stable Aggregate Supply and an Increase in Aggregate Demand: The Expansionary Gap SRAS 7 LRAS AD1 Price Level 120 E1 Real GDP per Year ($ trillions)

The Effects of Stable Aggregate Supply and a Increase in Aggregate Demand: The Expansionary Gap SRAS 7 LRAS AD2 AD1 Price Level 120 7.6 E1 Real GDP per Year ($ trillions)

The Effects of Stable Aggregate Supply and a Increase in Aggregate Demand: The Expansionary Gap SRAS 7 LRAS AD2 E2 7.2 Expansionary Gap 125 Price Level 120 120 7.6 E1 AD1 Real GDP per Year ($ trillions)

Explaining Inflation: Demand-Pull or Cost-Push? Demand-Pull Inflation Inflation caused by increases in aggregate demand not matched by increases in aggregate supply Whenever the general level of prices rise because of continual increase in AD Could occur when the amount of money in circulation increases faster than the growth of the economy

Intersection of AD2 and SRAS shows an increase in the price level. The Effects of Stable Aggregate Supply and an Increase in Aggregate Demand: Demand-Pull Inflation SRAS 7 LRAS AD2 AD1 125 E2 7.2 Demand-Pull Inflation Price Level 120 E1 Real GDP per Year ($ trillions) Intersection of AD2 and SRAS shows an increase in the price level.

Explaining Inflation: Demand-Pull or Cost-Push? Cost-Push Inflation Inflation caused by a continually decreasing short- run aggregate supply curve. Caused by an increase in costs of inputs which decreases SRAS. STAGFLATION!

The Effects of Stable Aggregate Demand and a Decrease in Aggregate Supply: Supply-Side Inflation 7 LRAS SRAS2 SRAS1 AD1 E2 125 6.8 Cost-Push Inflation Price Level 120 E1 Real GDP per Year ($ trillions)

The Oil Price Shock of the 1970s 3.0 LRAS SRAS shifted leftward due to the restrictions placed on the supply of oil to the U.S. SRAS2 SRAS1 AD1 E2 120 2.8 Price Level 115 E1 Real GDP per Year ($ trillions)

The Oil Price Shock of the 1970s Question What would have happened to the LRAS if the price of oil had remained permanently high?