Putting AD and AS together to get Equilibrium Price Level and Output

Inflationary and Recessionary Gaps 2

Example: Assume the government increases spending Example: Assume the government increases spending. What happens to PL and Output? LRAS Price Level AS PL and Q will Increase PL1 PLe Economy is in full employment AD1 AD QY Q1 GDPR 3

Inflationary Gap Output is high and unemployment is less than NRU LRAS Price Level AS Actual GDP above potential GDP PL1 Current output is BEYOND our natural employment levels. Puts upword pressure on prices AD1 Inflationary Gap QY Q1 GDPR 4

Stagnate Economy + Inflation Example: Assume the price of oil increases drastically. What happens to PL and Output? LRAS Price Level AS1 AS PL1 Stagflation Stagnate Economy + Inflation PLe Increase in price but less output (stagnate) AD Q1 QY GDPR 5

Recessionary Gap Output low and unemployment is more than NRU LRAS Price Level AS1 Actual GDP below potential GDP PL1 Recessionary Gap AD Q1 QY GDPR 6

How does this cartoon relate to Aggregate Demand? 7

Draw AD and AS at full employment LRAS AS Price Level P2 P1 AD2 AD=C+I+G+X Qf (Y*or FE) Q2 GDPR Output Increases PL Increases 8

Short Run and Long Run 9

Shifts in AD or AS change the price level and output in the short run LRAS Price Level AS PLe AD QY GDPR 10

Example: Assume consumers increase spending Example: Assume consumers increase spending. What happens to PL and Output? LRAS Price Level AS PL1 PLe AD1 AD QY Q1 GDPR 11

Now, what will happen in the LONG RUN? Inflation means workers seek higher wages and production costs increase LRAS Price Level AS1 AS PL2 Back to full employment with higher price level PL1 PLe AD1 AD QY Q1 GDPR 12

AS increases as workers accept lower wages and production costs fall Example: Consumer expectations fall and consumer spending plummets. What happens to PL and Output in the Short Run and Long Run? Price Level LRAS AS AS1 AS increases as workers accept lower wages and production costs fall PLe Short Run -AD Falls, PL and Q fall Long Run- AS Increases as workers accept lower wages and production costs fall. PL goes down, Q goes back to Full Employment PL1 PL2 AD AD AD1 Q1 QY GDPR 13