1. Aggregate Equilibrium

2. Review: AD, SRAS, & LRAS  AD = Sum of all demands for all the goods and services in all final markets  AD = C + G + I + X - M  Sum of all supply of all the goods and services in all final markets  Two types of AS: –Short-run AS: factor costs are fixed (wages and prices are “sticky”) –Long-run AS: factor costs change to meet market equilibrium (vertical)

3. Macroeconomic Equilibrium  Macroeconomic equilibrium occurs where SRAS and AD cross.  SRAS and AD have the same GDP and Price Level, so no shortage or surplus exists.  This may not cause full employment, so government policy and economic forces work to align this equilibrium with full employment.

4. Adding the LRAS  For simplicity, assume that full employment = natural employment  LRAS is determined by full employment (labor = resource bottleneck)  When all three curves meet, we usually are at the Non-Accelerating Inflation Rate of Unemployment (NAIRU)

5. Inflationary Gap  Caused by increase in AD or SRAS, without increase in LRAS  Usually caused by increase in AD  New equilibrium point is at higher price level  Healthy growth often comes with 3% rGDP growth and 2% inflation

6. Recessionary Gaps  Caused by decrease in AD or SRAS  Signifies unemployment higher than full  Modern economists now believe government action should be used to return equilibrium to LRAS

7. Shifts in both SRAS and AD  Concurrent shifts in SRAS and AD can lead to inflation without gains in employment or rGDP  Example: oil price rise decreases SRAS; increased population increases AD

8. Scenario 1  Phase 1: Government lowers income taxes. What happens to AD?  Phase 2: –Higher prices lower real wages, so people demand higher wages –Higher labor costs cause firms to reduce production at a given price, shifting SRAS to left and restoring full employment, but at higher price

9. Scenario 2  Phase 1: SRAS shifts left due to higher oil prices  Phase 2: –Shift causes rise in unemployment, higher prices –Government lowers taxes and increases money supply to shift AD to right, increasing employment but also raising prices