Macroeconomic Equilibrium Chapter 8

Potential GDP Potential GDP: the level of real GDP associated with full employment –sustainable upper limit of production = production possibilities frontier Actual real GDP can be –equal to potential GDP (at full employment) –greater than potential GDP (only temporarily) –or less than potential GDP ( in recession)

Labor Market Demand for labor –Relationship between the quantity of labor demanded and real wage rate –Shift of labor demand curve due to increase in productivity and increase in product demand Supply of labor –Relationship between the quantity of labor supplied and real wage rate –Shift of labor supply due to increase in working age population and preference changes Labor market equilibrium

Job Search and Job Rationing Job search and its duration depends on –Demographic changes occurring in population and households –Unemployment benefits –Structural changes Job rationing –When real wage rate is higher than the equilibrium level. Why? Because of Efficient wage Minimum wage law Union wage –Job rationing results in increase in natural unemployment.

Aggregate Demand AD (Aggregate demand): relationship between the quantity of real GDP demanded and the price level Inverse relationship (downward sloping curve) Shift of AD curve –Change in taxes or government purchases –Change in money supply and interest rate –Change in foreign income

Aggregate Supply AS (Aggregate supply): relationship between the quantity of real GDP supplied and the price level Direct relationship (upward-sloping curve) Shift of AS curve –Change in factors of production  change in potential GDP  change in AS –Change in cost of production factors (e.g. money wage rate, oil price)

Macroeconomic Equilibrium Aggregate demand and aggregate supply determine real GDP and the price level. Three types of macroeconomic equilibrium –Full-employment equilibrium –Above full-employment equilibrium –Below full-employment equilibrium Inflation and recession –Inflation occurs when AD increases more rapidly than AS. –Recession can occur when either AD or AS decrease.