 We will now consider AD and AS together  An economy’s equilibrium price level and real output occur at the intersection of the AD and AS curves 10.3 Equilibrium

Inventory Increase & Decrease  Imagine price level is above equilibrium price level, at “a”  At “a”, real output exceeds real expenditures, i.e. more is produced than purchased  Businesses have a surplus  “Positive Unplanned Investment”  An unintended rise in inventories causes businesses to lower prices until output and expenditures are at the same point, “B”  When price level is below eq. value “c”, there is an unintended fall in inventories, so businesses increase prices until equilibrium is reached, “b” Inventory Changes aa b c c

The Role of Unplanned Investment  Whether there is an unintended increase or decrease in inventory, unplanned investment plays a big role in stabilizing the economy  Unplanned Investment is the difference between AD and AS  The $20 trillion discrepancy between AD and AS at a price level of 100 means there is an unintended $20 trillion increase in inventories Inventory Changes

Movement toward equilibrium can also be seen by looking at flows of income payments and purchases that connect resource and product markets  3 Flows/Injections that add to the main income-spending stream in any economy:  Investment (I)  Government Purchases (G)  Exports (X)  3 outward flows/Withdrawals  Savings (S)  Taxes (T)  Imports (M) Injections & Withdrawals

The amount saved and invested in an economy are different  Companies keep a portion of profits to reinvest  Governments also borrow money  International flows (borrowing from foreign countries) Investment and Saving

 Transfer payments/business subsidies = “Negative Taxes”  At some points in time, government purchases exceed taxes, so they borrow money in financial markets  At other times, taxes exceed government purchases, so governments use excess revenues to pay off some outstanding debt Government Purchases & Taxes

 Typically, Canada imports more than it exports  i.e. we spend more on products from the rest of the world that receive revenues from selling products to rest of the world Exports & Imports

 While individual injections and withdrawals aren’t necessarily equal, they all balance each other overall, otherwise Canada’s economy wouldn’t be working as it is  Total Injections = I + G + X  Total Withdrawals = S + T + M  If TI > TW, we have an expanding economy  If TI < TW, we have a declining economy  If TI = TW, we have equilibrium Total Injections & Withdrawals

 Recessionary Gaps An economy’s real output rarely equals its potential output If equilibrium output is below potential level, unemployment is above the natural unemployment rate Difference between equilibrium output and potential output is known as a recessionary gap Vertical, purple line is potential output Equilibrium vs Potential Output

 Inflationary Gaps If equilibrium output is above potential level, unemployment is below the natural unemployment rate Inflation will accelerate if this situation persists Difference between equilibrium output and potential output is known as an inflationary gap Vertical, purple line is potential output *Note* a recession differs from a recessionary gap. Coming up: during a recession, real output moves from above to below its potential level Equilibrium vs Potential Output