1. Aggregate Equilibrium
Macroeconomic Theory

2. 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
Unemployment high, output low
Below PPF, Actual Px level < Expected
Unemployment very low, output high
Above PPF, Actual Px level > Expected

3. Short Run vs. Long Run
In short run, a shift in AD cause changes in real GDP, Unemployment & price level
In long run, wages & prices are not “sticky” and do not affect output
Prices are perfectly flexible in long run
Actual price level must equal expected price level

4. LONG RUN EQUILIBRIUM IN LONG RUN EQUILIBRIUM: This must be true:
Expected Price Level = Actual Price Level
Employment = Full Employment
Real GDP = Potential Output
Quantity = Natural rate a( Actual Px Expected Px)
Supplied of Output ( Level Level )

5. Example: Stock Market Crash
2- causes output to fall in short run . . .
Short run —Step 1 & 2
Price
Long Run– Step 3 & 4
Level
LRAS
SRAS1
AD1
SRAS2
AD2
but over
time, the SRAS
Shifts as expected
Price level falls
. . A P Y B P2 Y2
1-Decrease in AD C P3
and output returns
to its natural rate. .
Real GDP

6. Worksheet

7. Analyzing Economic Changes
Four step process:
(1) Determine if the event affects SRAS, LRAS or AD
(2) Decide which direction curve shifts
(3) Compare the initial & new equilibrium
(4) Determine both short & long run equilibrium

8. Stagflation A period of recession and inflation.
Output falls & price level rises
Example: late 1970’s in USA (oil crisis)
Challenge: Policymakers who can influence aggregate demand cannot offset both simultaneously

9. “Supply Shock” in SRAS
Consider an adverse shift in short run aggregate supply:
curve shifts to the left
Output falls below natural rate of employment
BOTH unemployment & price level rise

10. Example: “Supply Shock”
1. An adverse shift in SRAS
(supply shock).
Price
Level
LRAS
SRAS2
SRAS1 AD B Y2 P2 Y A P
and
the price
level to rise.
Quantity of
causes output to fall . . .
Output