Macroeconomics – Unit 3 part 5

PL

Q=realGDP=Y

AD

LRAS

PL1

YF

SRAS

Y1

Short Run Equilibrium occurs where _____ & _____ intersect & then you determine the _____ & _____ for the economy.

ADSRAS

PL Y

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Short-Run Equilibrium

PL

Q=realGDP=Y

SRAS

PL1

PL2

Q1Q2

AD

Q3

What is going on in the economy if PL is at P2?

aggregate demand ________ aggregate supply firms experience reduction of ____________ firms increase __________ & ___________ bringing output towards - equilibrium level.

exceeds

inventories

production employment

Long Run Equilibrium – where SRAS, AD & LRAS intersect.

PL

Q=realGDP=Y

LRAS

Y

When the economy is in long run equilibrium, aggregate demand grows at the same rate as potential output, so there are no pressures on the economy to raise prices or reduce production, etc. Growth and employment are at target rates and inflation is minimal.

AD

SRAS

Recessionary Gap – amount by which the short run equilibrium is below potential output

PL

Q=realGDP=Y

LRAS

YF

So what must happen to bring the economy to long run equilibrium?

AD

SRAS

Y1

PL1

What is the value of the recessionary gap on this graph?

YF – Y1

Recessionary Gap – could be fixed by...

PL

Q=realGDP=Y

LRAS

YF

AD

SRAS

Y1

PL1

(1) shift in SRAS – b/c economy is producing at a level ________ potential output,

below __________ are sitting

around unused costs and wages tend to _____ price level falls and SRAS shifts _____ until equilibrium.

resources

fall

right

theoretically, that is....

SRAS2

Recessionary Gap – could be fixed by...

PL

Q=realGDP=Y

LRAS

YF

AD

SRAS

Y1

PL1

(2) shift in AD – much more often what happens is ... the Government uses fiscal

taxes

policy or monetary policy to stimulate or slow down economy. Fiscal policy – deliberate change in _____ or government ________ to expand or contract AD.

spending

AD2

PL2

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Inflationary Gap–amount by which the aggregate expenditures (AD) are above potential output.

PL

Q=realGDP=Y

LRAS

YF

How is it possible to produce beyond potential resources?

AD

SRAS

Y2

PL1

What is the value of the inflationary gap on this graph? Y2 – YF

Extra shifts, machinery run 24 hours, but workers become exhausted & machinery wears out; output must return to its potential

Inflationary Gap – could be fixed by... (1) shift in SRAS – b/c economy is producing at a level ________ potential output,

above there is a huge

demand for ________ costs and wages _____ price level rises and SRAS shifts _____ until equilibrium.

resources

rise left

theoretically, that is....

PL

Q=realGDP=Y

LRAS

YF

AD

SRAS

Y1

PL1

SRAS2

PL2

Inflationary Gap – could be fixed by...

fiscal

PL

Q=realGDP=Y

LRAS

YF

AD

SRAS

Y1

PL1

AD2

PL2

(2) shift in AD – much more often what happens is ... the Government uses _______ ________ or

________ policy to stimulate or slow down economy. Here gov’t would increase _____ or cut _______ to get AD to shift left.

policy monetary

taxes spending

Sample problem...starting economy at full employment...price is ___ and output is ___.P0

The exchange rate falls dramatically making exports ________ _____ shifts ______ PL _______ & output _________.

increase AD right

PL

Q=realGDP=Y

LRAS

YF

AD1

SRAS

Y1

PL1

AD

PL0

YF

risesincreases

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But next you have long-term adjustment ... (assuming the gov’t hasn’t stepped in with fiscal or monetary policy)

PL

Q=realGDP=Y

LRAS

YF

AD1

SRAS

Y1

PL1

SRAS2

PL2

ADPL0

There is a huge demand for __________ & with a higher PL labor pushes for higher _______ costs and wages _____ price level rises and SRAS shifts _____ until equilibrium. But now new equilibrium is at the ______ output, but ______ Price Level.

resources

rise

left

wages

higher

same

This is called long-term adjustment. It assumes no intervention by the ____________.

On an AP free response question or IB question, you would be expected to correctly graph that process as well as explain it verbally.

government

Classwork

AP workbook p. 143-146, Activity 28

15 min

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