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Graphing Macroeconomic Problems
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Full Employment (F.E.) – There is between 5% and 5.5% unemployment in the economy There is 0% cyclical unemployment
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P AS AD= C+I+G+NX ☺ F.E. RGDP
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There are 3 macroeconomic Problems I. The Recessionary Gap - caused by a leftward shift in the AD curve (AD is too low)
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AD shifts leftward when either C, I, G, or NX decrease ex: Consumer confidence falls causing C to fall
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P AS AD= C+I+G+NX AD’ RGDP C F.E. RGDP Rec. GAP
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Three things to note from the Recessionary Gap: 1. RGDP is lower than it would be at F.E. 2. Unemployment is higher than it would be at F.E.
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3. The average price level is lower than normal (inflation is not a problem)
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II. The Inflationary Gap - caused by a rightward shift in the AD curve (AD is too high)
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AD shifts rightward when either C, I, G, or NX increase ex: The government increases military expenditures causing G to increase
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P AS AD’ AD= C+I+G+NX F.E. RGDP C RGDP Infl. GAP
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Three things to note from the Inflationary Gap: 1. RGDP is higher than it would be at F.E. 2. Unemployment is lower than it would be at F.E.
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3. The average price level is higher than at F.E. (Inflation is getting out of control)
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III. Stagflation - caused by a leftward shift in the AS curve
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AS shifts leftward when the cost of production increases ex: the price of oil, a major input increases
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P AS’ AS AD=C+I+G+NX RGDP C F.E. RGDP
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Three things to note from Stagflation: 1. RGDP is lower than it would be at F.E. 2. Unemployment is higher than it would be at F.E.
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3. The average price level is higher than at F.E. (Inflation is getting out of control)
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During the Oil Crisis of the late 1970’s and early 1980’s both the inflation rate and the unemployment rate exceeded 10% Misery Index: The inflation rate + the unemployment rate
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If the AS curve shifts to the right, no problem is created. RGDP increases, while neither unemployment nor inflation increase. F.E. increases due to economic growth
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P AS AS’ AD=C+I+G+NX F.E. F.E.’ RGDP
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If the government takes no action, the economy will naturally, over time, return to F.E. (the long run equilibrium point in the economy)
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If the economy is experiencing high unemployment (rec. gap or stagflation) then there is a surplus of workers on the market
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This surplus causes the price of workers (real wages) to fall That is, workers’ salaries don’t keep up with inflation
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Lower wages reduce the cost of production which in turn shifts the AS curve rightward bringing the economy back to F.E.
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P AS AS’ AD= C+I+G+NX AD’ RGDP C F.E. RGDP Rec. GAP
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If the economy is experiencing a shortage of workers (Inflationary Gap) then real wages will be bid upwards
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This causes the cost of production to increase and the AS curve to shift leftward bringing the economy back to F.E.
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P AS’ AS AD’ AD= C+I+G+NX F.E. RGDP C RGDP Infl. GAP
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