6. Equilibrium GDP and Prices
i. describe how fluctuations in aggregate demand and aggregate supply cause short-run changes in the economy and the business cycle;
j. distinguish between the following types of macroeconomic equilibria: long-run full employment, short-run recessionary gap, short-run inflationary gap, and short-run stagflation;
k. explain how a short run macroeconomic equilibrium may occur at a level above or below full employment;
l. analyze the effect of combined changes in aggregate supply and demand on the economy;
When does short-run macroeconomic equilibrium occur?
Short-run macroeconomic equilibrium occurs when the quantity of real GDP demanded equals the quantity of real GDP supplied at the point of intersection of the AD curve and the SAS curve.
- AD = Aggregate demand
- SAS = Short-run aggregate supply (slopes up-and-to-the-right)
When does Long-run macroeconomic equilibrium occur?
Long-run macroeconomic equilibrium occurs when real GDP equals potential GDP - when the economy is on its LAS curve.
- LAS = Long-run aggregate supply (vertical bar)
How does economic growth occur?
Economic growth occurs because the quantity of labor grows, capital is accumulated, and technology advances, all of which increase potential GDP and bring a rightward shift of the LAS curve.
- LAS = Long-run aggregate supply
How does inflation occur?
Inflation occurs because the quantity of money grows faster than potential GDP, which increases aggregate demand by more than long-run aggregate supply. The AD curve shifts rightward faster than the rightward shift of the LAS curve.
What is "below full-employment equilibrium"? What is a recessionary gap?
A below full-employment equilibrium is an equilibrium in which potential GDP exceeds real GDP. The amount by which potential GDP exceeds real GDP is called a recessionary gap.
What is "long-run equilibrium"?
Long-run equilibrium is an equilibrium in which potential GDP equals real GDP.
What is "above full-employment equilibrium"? What is an inflationary gap?
An above full-employment equilibrium is an equilibrium in which real GDP exceeds potential GDP. An inflationary gap is the amount by which real GDP exceeds potential GDP.
What is stagflation?
As the SAS curve shifts leftward, real GDP decreases and the price level rises. The combination of recession with inflation is called stagflation.
- SAS = Short-run aggregate supply