Download Short-run Aggregate Supply, Long

The Theor}'of Short-TermEconomicGrowth
Economic growth theory states that the potential GDP of an
economy is best calculated by what it makes, its aggregate
(total) supply (AS). There are two types of aggregate supply.
Short-run aggregate supply (SRAS) is all of the goods and
services produced in the short-run (SR) (up to one year out) by
all of the firms in an economy using the available labor,
capital, and technology. The curve is sloped because of the
law of supply . .
n
Increase
PL
decrease
SRAS
2
SRAS
1
SRAS2
P2
Pl
Y1
Y2
y
RealGDP
Page1
Y2
Y1
y
RealGDP
The Theor}'of Short-TermEconomicGrowth(cont.)
SRAS is referred to as a supply-side policy because it deals
with the total supply of goods and services in an economy.
SRAS assumes that there are fixed costs (FC) that cannot be
changed in the short-run (SR), but the variable costs (VC) can
be changed.
**Variables
thatimpactSRAS**
1. resource/input costs for production- wages, salaries, the
costs of materials, supplies, equipment, technologies, and
facilities
2. inflation expectations
3. subsidies (payments by governments) to producers
4. taxes on producers
Page2
The Theor}'of Short-TermEconomicGrowth(cont.)
When the level of short-run aggregate supply (SRAS)is the
same as aggregated demand (AD), short-run (SR) equilibrium
occurs. Short-run equilibrium is a state where aggregate
supply (AS) equals aggregate demand (AD) in the short-run
(SR) (less than one year). The price level is the measurement
of current prices of goods and services produced in the
economy in a specific region or country at a specific time.
Short -ru n eQui
i b r iu m output
Pr ce l evel
SR.AS
p
AD
O ______
Page3
v_____
o_u-tputRG()P
The Theor}'of Short-TermEconomicGrowth(cont.)
Expansionary monetary policy increases the price level, but a
continual increase in the price level causes inflation. A
decrease in the money supply decreases the price level but
doesn't change output levels. The equilibrium price level and
equilibrium output level are the market price and output
where the quantity of goods supplied (Qs) is equal to the
quantity of goods demanded (Qd).
Short
- run
equ
P · ce l eve l
i i br·um
output
SRAS
p
AD
0
Page4
y
Ou
p
t
The Theor}'of Short-TermEconomicGrowth(cont.)
The SRAS curve shifts right (increases) if the stock (worth) of
physical capital (trucks, factories) increases. An increase in
government expenditures (spending) will also shift the SRAS
right as will increased numbers of workers enterring the labor
force. A decrease in input resource prices for AS increases
SRAS but decreases the price level (prices). Real output will
then increase but not inflation until demand itself increases.
PL
SRAS2
P1
P2
Y1
Y2
y
R eal
Page5
GDP
The Theor}'of Short-TermEconomicGrowth(cont.)
An increase in SRAS will lead to increases in income and
possibly unemployment because an increase in demand will
follow increased supply. Unanticipated increases in SRAS can
cause hyperinflation because the excess supply will increase
demand.
PL
SRAS2
P1
P2
AD
V1
V2
y
Real
Page6
GDP
The Theor}'of Short-TermEconomicGrowth(cont.)
SRAS can also shift left (decrease.) A decrease in labor
productivity, and an increase in production costs/per unit costs
all decrease SRAS. If SRAS decrease then aggregate demand
(AD) increases, the price level will increase.
PL
SR.AS 2
SRAS
1
PL ---------------P2
P1
,.
........ . . . ........... ..... ................... ............-:..-............
..
AD \
Y2
-·--·----
Page7
Y1
___
-r- __
'f3
- l -----
y
Real GDP
The Theor}'of Short-TermEconomicGrowth(cont.)
When SRAS decreases but AD stays the same, stagflation
occurs. When SRAS decreases rapidly but AD increases, like
with a natural disaster, the price level goes up and real wages
decline. This is referred to as demand-pull inflation.
stagflation
demand-pull inflation
PL
SRAS2
SRAS1
PL
P2
Pl
Y2
Yl
y
RealGDP
Page8
Y2
Yl
y
RealGDP
The Theor>'of Short-TermEconomicGrowth-?s
3. A rightward hift in the hort -run aggregate
upply curve will occur when
A
(B
C
D
(E
export exceed impor
the money upply increa e
the price of imported raw material increa e
the tock of phy ical capital incre e
union have negotiated a wage increa e for
their membet
14. An increa e in which of the following would mo t
likely re ult in an increa e in aggregate upply?
(A
(B
(C
(D
E
Page9
The price level
Aggregate demand
Unemployment compen ation
Labor-force pa1ticipation rate
The minimurn wage
The Theor>'of Short-TermEconomicGrowth-?s
3. A rightward hift in the hort -run aggregate
upply curve will occur when
A
(B
C
•
(E
export exceed impor
the money upply increa e
the price of imported raw material increa e
the tock of phy ical capital incre e
union have negotiated a wage increa e for
their membet
14. An increa e in which of the following would mo t
likely re ult in an increa e in aggregate upply?
(A
(B
(C
(•
E
Page10
The price level
Aggregate demand
Unemployment compen ation
Labor-force pa1ticipation rate
The minimurn wage
The Theoryof Short-TermEconomicGrowth-?s
40. An increa e in which of the following i mo t
likely to cau e the hort-run aggregate upply
curve to hift to the left?
A
(B
C
D
(E
Con umer ' income
The money upply
Go ernment pending
The optimi m of busine firm
The per unit co t of production
10. If a reduction in aggregate upply i followed by
an increa e in aggregate dernand, which of the
following will definitely occur?
(A
(B
(C
(D
(E
Page11
Output will increa e.
Output will decrea e.
Output will not change .
The price le el will increa e.
The price le el will decrea e.
1
The Theoryof Short-TermEconomicGrowth-?s
40. An increa e in which of the following i mo t
likely to cau e the hort-run aggregate upply
curve to hift to the left?
A
(B
C
D
Con umer ' income
The money upply
Go ernment pending
The optimi m of busine firm
(e ) The per unit co t of production
10. If a reduction in aggregate upply i followed by
an increa e in aggregate dernand, which of the
following will definitely occur?
(A Output will increa e.
(B Output will decrea e.
(C Output will not change .
(e The price le el will increa e.
(E The price le el will decrea e.
1
Page12
The Theorl'of Short-TermEconomicGrowth-?s
2 1. With an up war d-slopin g hort -run aggrega t e
uppl y curve an in crea e in gove rnm en t
ex penditur e will mo st lik e ly
(A ) redu ce th e price leve l
(B ) redu ce th e l eve l of nomin al gro do m e ti c
pr odu ct
(C ) in crea e rea l gross dome tic pr odu c t
(D ) hi f t th e hort -run agg regate uppl y curv e to
th e ri ght
(E) hi f t both th e agg rega te detna nd cu rve and
th e lon g- run agg rega te uppl y curve to th e
left
48_ A decr eas e in th e price s of inputs "vill cause
w hich of the following to occur in the short run ?
(.4~) An increas e in the aggregate demand
(B )
(C)
(D )
(E)
Page13
and an
.increase in the pric e leve l
A decrease in the aggregate demand and an
increas e .in the price level
An increas 1e in the short-run aggrega t e supply
and a decrease in the price le-vel
An increase in the short-run aggregate supply
and an increase in the price level
A decrease in the short-run aggregate suppl y
and a decre ase in the pric e level
The Theorl'of Short-TermEconomicGrowth-?s
2 1. With an up war d-slopin g hort -run aggrega t e
uppl y curve an in crea e in gove rnm en t
ex penditur e will mo st lik e ly
(A ) redu ce th e price leve l
(B ) redu ce th e l eve l of nomin al gro do m e ti c
pr odu ct
•
in crea e rea l gross dome tic pr odu c t
(D ) hi f t th e hort -run agg regate uppl y curv e to
th e ri ght
(E) hift both th e agg rega te detna nd curve and
th e lon g- run agg rega te uppl y curve to th e
left
48 _ A decr ease in the price s of inputs will cause
which of the foll owing to occur in the short run ?
(A) An increa se in the aggregate demand and an
increase in the pric e level
(B) A decrease in the aggregat.e demand and an
increase .in the price level
•
An increase in the short -run aggregat e supply
and a decrease in the price lev el
(D ) An increase in the sh ort-run aggregate supply
and an increase in the price level
(E) A decrease in the short-rnn aggregate suppl y
and a decrea se in the pric,e level
Page14
Macroeconomics
Do-Now
Please do this:
1. Assume the U.S. economy is in short-run equilibrium
(real GDP is on the potential GDP line). Is there any
monetary policy the Fed should take? Why?
a. Draw a correctly labeled graph and show each of the
following:
i. current equilibrium output and price level, labeled OE
and PE
2. Assume that the Fed buys more bonds from banks.
a. Show the impact on your graph, labeling the new real
GDP as 02 and price level as PE2.
3. Now assume something has increased production costs
in the country.
a. Show the impact on your graph, labeling the new output
of production 03 and price level as PE3.
Page15
Macroecono .
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WICS Do-Now
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Page16
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The Theor}'of T,ong-TermEconomicGrowth
Long-run aggregate supply (LRAS) is all of the goods and
services produced in the long-run (LR- four to five years out)
by all of the firms in an economy using the available labor,
capital, and technology . The curve is perfectly vertical because
it reflects economists' belief that changes in aggregate demand
(AD) have only a temporary change on the economy's total
output and because it indicates immediate adjustments between
wages and the price level as they fluctuate over time. The
LRAS curve is determined by all of the factors of production
since none are fixed in the LR.
fC'ic.e..le"al
PL
1. full employment
level
2. full output level
3. natural rate of
unemployment
P1
AD
Y:1.
Page17
2
The Theor}'of T,ong-TermEconomicGrowth(cont.)
Long-run equilibrium is a state where long-run aggregate
supply (LRAS) equals aggregate demand (AD) in the long-run
(LR) (four to five years and beyond). Long-run equilibrium is
where real GDP (Y) equals potential GDP. When both the
LRAS and AD shift right (increase), output increases but the
new price level is unknown at first. This is known as a
double-shift.
~,
Price
Level
~Q
L \<..C?,..
\
\Jl"l \
Long~un
Aggregate
Sup p ly
Output
Page18
LRAS
LRAS 2
~
1. full employment
level
2. full output level
3. natural rate of
unemployment
AD2
_-'=:=:::-~
~n~ ...:!ll
~v2~=
=--;
v
RealGDP
The Theor}'of T,ong-TermEconomicGrowth(cont.)
The LRAS curve represents an economy where all inputs: land,
labor and capital, are used to full efficiency. The LRAS curve
indicates where full employment and full output are in an
economy and also the natural rate of unemployment occur. If
there was an increase in investment, growth in size of a skilled
labor force, a right shift in the production possibilities
curve/frontier, or consumer confidence in the economy grows,
LRAS shifts to the right. When LRAS shifts to the right, it's an
indicator of positive eE) ~mic growth.
\<-.e.
1. full employment
level
2. full output level
3. natural rate of
unemployment
\
"e.\
2
LR As
LR AS
P1
AD2
Y1
Y2
Y
Real
Page19
GDP
The Theor}'of T,ong-TermEconomicGrowth(cont.)
The LRAS also shows wages over time shifting to the
prevailing price level. Classical economists believe that the
close alignment of wages and the price level allow a country to
naturally return to long-run equilibrium, even when
unemployment or inflation occurs.
--•
-
RecessionaryGa,p
lnffatlonaryGap
LRAS
LRAS
0...
1. full
employment ~
level
~
2. full output
~
S·RAS1 level
3. natural rate
of
unemploy-
ment
~ea GDP
Page20
YF >y 1
Real GDP
The Theor}'of T,ong-TermEconomicGrowth(cont.)
Long-run aggregate supply (LRAS) can be impacted by
changes in input or output costs, taxes, subsidies, government
regulations, and the production of capital goods (goods
created in order to produce other goods, like a robot for a car
factory) and consumer goods (goods created for consumer
purchase, like twinkies ). Labor is the total number of hours
that workers are available to work in producing real GDP.
Capital is the total number of factories, machines, computers,
human workers, etc., available. Technology is the total
amount of know-how available.
Page21
The Theorl'of T,ong-Term
EconomicGrowth-?s
27. The hort -run aggregate upply curve would be
vertical if
(A) nominal wage adjust immediately to
change in the price level
(B ) nominal wage adjust lowly when there is
unemployment
(C) both nominal wage and prices adju t
lowly to change in aggregate demand
(D ) the pendin g rnultiplier i very low
(E) investment demand i very re pon ive to
change in intere t rates
43. An increase in con umer confidence will re ult in
which of the following in the short run?
(A) A rightward shift of the long -run aggregate
supply curve
(B) A rightward hift of the hort -run aggregate
supply curve
(C) A leftward shift of the hort-run aggregate
supply curve
(D) A rightward shift of the aggregate demand
curve
(E) .t-\ leftward hift of the aggregate demand
curve
Page22
The Theorl'of T,ong-Term
EconomicGrowth-?s
27. The hort -run aggregate upply curve would be
vertical if
ce nominal
wage adjust immediately to
change in the price level
(B ) nominal wage adjust lowly when there is
unemployment
(C) both nominal wage and prices adju t
lowly to change in aggregate demand
(D ) the pendin g rnultiplier i very low
(E) investment demand i very re pon ive to
change in intere t rates
43. An increase in con umer confidence will re ult in
which of the following in the short run?
(A) A rightward shift of the long -run aggregate
supply curve
(B) A rightward hift of the hort -run aggregate
supply curve
(C) A leftward shift of the hort-run aggregate
supply curve
(.
A rightward shift of the aggregate demand
curve
(E) .t-\ leftward hift of the aggregate demand
curve
Page23
Macroeconomics
Do-Now
Please do this:
1. Assume the U.S. economy is in long-run equilibrium. Is
there any monetary policy the Fed should take? Why?
a. Draw a correctly labeled graph and show each of the
following:
i. current equilibrium output- 0 and price level- P
2. Assume that the government starts to spend more money
on defense.
a. Show the impact on your graph, labeling the new real
GDP as 02 and price level as P2.
3. Based on what you graphed above, is the U.S. economy
in contraction or expansion? Explain?
4. Based on what you decided in 3, draw an economic
fluctuations model on a potential GDP line and also a
production possibilities curve, both showing where the
economy currently is.
Page24
Macroeconomics
Do-Now
AO~ l~':J
1. full employment level
2. full output level
3. natural rate of unemployment
Page25
sRAS
AggregateDemandandEconomicFluctuations
The theory of economic fluctuations emphasizes fluctuations in
the total demand for goods and services as the reason for the
ups and downs in the economy. Because the focus is on the
total of the demand for all goods and services in the economy
and not just one industry, like when we learned about demand
(D) in microeconomics, we use the term aggregate demand
(AD). More precisely, aggregate demand is the total amount
that consumers (C), businesses (J), the government (G), and
foreigners (net exports-imports) (X) spend on all goods and
services in an economy. AD is referred to as a demand-side
policy because it deals with the total demand of goods and
services in an economy. Any change in AD can impact the
wealth in a society.
Page26
AggregateDemandand EconomicFluctuations(cont.)
The inflation rate is not the only thing that affects aggregate
demand (AD). Changes in government purchases, monetary
policy, foreign demand for U.S. exports, taxes, and consumer
confidence can affect aggregate demand and cause a shift in
•
th e AD ltne.
Th e AD cur\'e is shifted to th e right
I NFLAT ION
HAT E
by:
l)
2)
:~)
4)
5)
a n inc.:rease in government pur chases
a clec·rca.scin taxes
an ups hift in for e ig n de mand
an UJ>
s hift in co n sump tion
a mo netary poli cy shift to a
highe r inflati o n targ et.
Three AD curves
Th e AO cur, ·c is s hift e d to the left by:
I) a clrcrc ase in governm e nl pur ch ,U:CS
2) an inc reas ' in taxe s
:3) a dmvns hirt in fore ign demand
,l) a down hift in con ·umpt ion
6) a monetar y polic;y shift to a lower
i nnation target.
R F'.A
t
Page27
GDP
AggregateDemandand EconomicFluctuations(cont.)
According to the economic fluctuations theory, the increases in
real GDP over potential GDP are caused by increases in
aggregate demand and decreases in real GDP (Y) below
potential GDP during recessions are caused by declines in
aggregate demand (AD). Government military spending
during (increased) and after (decreased) the Cold War is an
example of both. Increases in C, 1, G, or X can cause increase
in real GDP (Y) and a rightward shift.
B.1.U(l~~cn·
1()021~• 1,l.\k >.
V.fi>Or
Panel (a)
----------
An increase i n aggregate
d emand
1.20
Panel (b)
An decre ase in agg regate
demand
AA~
1.20
0
q
1.18
~
Bu.1.1
0-.~r,r
L91i200I.L\lll!
~ 1.16
1.16
C'O
~ ll](l r
~
j,1)1.111~
~
li.OIIOI
C'O
.::;
.o:io-
- --------
1.12
<ii
~
1.12
QJ
u
1.10
&:
$11,600 11,800 12,000 12,200 12,400 12,600
Page28
-+--
8
4,1'.00
:JJ)O{I
1.14
1.10
$11,600 11,800 12,000 12,200 12,400 12,600
AggregateDemandand EconomicFluctuations(cont.)
An increase in AD increases the price level. When income
taxes decrease, AD increases. A decrease in the money supply
can decrease AD. If a decrease in AD creates a recession, the
price level and real output will both decrease. Unemployment
will also increase and the inflation rate will decrease if AD
decreases and price and wages don't quickly adjust to the
change.
Panel {a)
Panel (b)
An increase in aggrega te
An decrease
demand
1.20
1.18
in aggregate
d emand
1.20
AAS
0
SRAs
1.18
~
,--
~ 1.16
1.16
re,
QJ
>.
~
1.14
re,
1.14
-
..0
<ii
1.12
>
1.12
QJ
QJ
u
~ 1.10
1.10
$ 1 1,600 1 1,800 12,000 12 ,200 12,400 12,600
Page29
A0
1
S1 1,600 1 1,800 12,000 12,200 12,400 12 ,600
AggregateDemandand EconomicFluctuations-?s
35. Following a decrease in aggregate demand ,
an increase in unemployment will result if
(A) prices increase and real wages decrease
(B) the aggregate supply curve is vertical
(C) price s and wage s quickly adjust to
equilibrium levels
(D) short-run aggregate supply also increases
(E) prices and nominal wages are slow to adju t
in the short run
12. An increa e in the price of a key input will cau e
the aggregate demand curve and the hort -run
aggregate upply curve to change in which of the
following ways?
Aggregate
Demand Curve
(A
(B
(C)
(D
Shift to the right
Shift to the left
Shift to the left
No change
(E No change
Page30
Aggregate
Supply Curve
Shift to the
Shift to the
No change
Shift to the
Shift to the
right
left
left
right
AggregateDemandand EconomicFluctuations-?s
35. Following a decrease in aggregate demand ,
an increase in unemployment will result if
(A) prices increase and real wages decrease
(B) the aggregate supply curve is vertical
(C) price s and wage s quickly adjust to
equilibrium levels
(D) short-run aggregate supply also increases
(e ) prices and nominal wages are slow to adju t
in the short run
12. An increa e in the price of a key input will cau e
the aggregate demand curve and the hort -run
aggregate upply curve to change in which of the
following ways?
Aggregate
Demand Curve
(A
(B
(C)
(. )
Shift to the right
Shift to the left
Shift to the left
No change
(E No change
Page31
Aggregate
Supply Curve
Shift to the
Shift to the
No change
Shift to the
Shift to the
right
left
left
right
AggregateDemandand EconomicFluctuations-?s
41. An unanticipated decrea e in aggregate demand
will rno t likely cause the unemployment rate
and the inflation rate to change in which of the
following ways?
(A)
(B)
(C)
(D)
(E)
Unemployment
Rate
Increa e
Increa e
Increa e
Decrease
Decrea se
Inflation
Rate
Increa e
Decrease
No change
Increa e
Decrease
48. The aggregate demand curve as ume that
(A) as the price of a good or ervice increase s
nominal wage decrease
(B) as the dome tic price level increa e
consumer ubstitute domestic good for
foreign goods
(C) all price and total con umer income are
con tant
(D) changes in the price level affect real wealth
(E) nominal intere t rate increa e as the price
level decrea e
Page32
AggregateDemandand EconomicFluctuations-?s
41. An unanticipated decrea e in aggregate demand
will rno t likely cause the unemployment rate
and the inflation rate to change in which of the
following ways?
(A)
•
(C)
(D)
(E)
Unemployment
Rate
Increa e
Increa e
Increa e
Decrease
Decrea se
Inflation
Rate
Increa e
Decrease
No change
Increa e
Decrease
48. The aggregate demand curve as ume that
(A) as the price of a good or ervice increase s
nominal wage decrease
(B) as the dome tic price level increa e
consumer ubstitute domestic good for
foreign goods
(C) all price and total con umer income are
con tant
•
changes in the price level affect real wealth
(E) nominal intere t rate increa e as the price
level decrea e
Page33
AggregateDemandand EconomicFluctuations-?s
Long-run
Aggregate
Supply
(LRAS )
Short -run
Aggregate
Supply
(SRAS)
Aggregate Demand (AD )
Yr
OUTPUT
57 . Accordin g to the graph above whi ch of the
followin g statements about the eco nomy i Uue?
(A) The econom y is in long-run equilibrium .
(B) The LRAS cu rve will automatically shift to
the right restoring long-run equilibrium .
(C) In the short run, if wages are sticky the SRAS
will shift to the right lowering price .
(D) The economy is in a reces ion , requirin g
decreases in pending to re tore full
emplo yment.
(E) Wages will eventuall y decrease, restoring full
employm ent in the long run .
Page34
AggregateDemandand EconomicFluctuations-?s
Long-run
Aggregate
Supply
(LRAS )
Short -run
Aggregate
Supply
(SRAS)
Aggregate Demand (AD )
Yr
OUTPUT
57 . Accordin g to the graph above whi ch of the
followin g statements about the eco nomy i Uue?
(A) The econom y is in long-run equilibrium .
(B) The LRAS cu rve will automatically shift to
the right restoring long-run equilibrium .
(C) In the short run, if wages are sticky the SRAS
will shift to the right lowering price .
(D) The economy is in a reces ion , requirin g
decreases in pending to re tore full
emplo yment.
•
Wages will eventuall y decrease, restoring full
employm ent in the long run .
Page35
AggregateDemandandEconomicFluctuations-?s
...J
u.l
>
u.l
~
u~
c2
Cl..
AD 1
0
REA GROSS DOMESTIC PRODUCT
17. The graph above show two aggregate demand
curves AD 1 and AD 2 and an aggregate upply
curve AS. The shift in the aggregate demand
curve from AD 1 to AD 2 could be caused by
(A)
(B)
(C)
(D)
(E)
Page36
a decrease in taxe
a decrease in the money upply
an increase in government pending
an increase in con umption spending
an increase in the price level
AggregateDemandandEconomicFluctuations-?s
...J
u.l
>
u.l
~
u~
c2
Cl..
AD 1
0
REA GROSS DOMESTIC PRODUCT
17. The graph above show two aggregate demand
curves AD 1 and AD 2 and an aggregate upply
curve AS. The shift in the aggregate demand
curve from AD 1 to AD 2 could be caused by
(A)
•
(C)
(D)
(E)
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a decrease in taxe
a decrease in the money upply
an increase in government pending
an increase in con umption spending
an increase in the price level
AggregateDemandand EconomicFluctuations-?s
19. Which of the fallowing will cau e an increa e in
aggregate demand?
(A) An increa e in the price level
(B) A decrease in income taxe
(C An increa e in the demand for money
(D) A decrea e in the supply of money
(E) A decrea e in government transfer payments
60 . Which of the following will hift the aggregate
demand curve to the right?
(A) A report that corporate earning were lower
than expected
(B) An increa e in intere t rate cau ed by
a tightening of monetary policy
(C) Increased import caused by appreciation
of the dollar
(D) Increased pending by bu ine e on
computers
(E) An increa e in the government budget
urplu
Page38
AggregateDemandand EconomicFluctuations-?s
19. Which of the fallowing will cau e an increa e in
aggregate demand?
(A) An increa e in the price level
(. ) A decrease in income taxe
(C An increa e in the demand for money
(D) A decrea e in the supply of money
(E) A decrea e in government transfer payments
60 . Which of the following will hift the aggregate
demand curve to the right?
(A) A report that corporate earning were lower
than expected
(B) An increa e in intere t rate cau ed by
a tightening of monetary policy
(C) Increased import caused by appreciation
of the dollar
(e ) Increased pending by bu ine e on
computers
(E) An increa e in the government budget
urplu
Page39
AggregateSupplyand DemandTogether
As seen below, the difference between potential GDP and real
GDP (I) is called the recessionary gap (potential GDP minus
real GDP) because real GDP in a country is lower than
potential GDP at the full employment level. Classical
economists feel that the economy will work itself out: wages
and the price level will drop and the economy will get back to
full employment in the long-run (LR).
Reces5lonary
Gap
1. full employment
>
LRAS
__,
u
level
SRAS
2. full output level
3. natural rate of
unemployment
0....
Q)
Q)
Q)
·c:
0..
AD
~ea GDP
Page40
AggregateSupplyand DemandTogether(cont.)
The difference between potential GDP and real GDP (I) is
called the inflationary gap (real GDP minus potential GDP)
because real GDP in a country is higher than potential GDP at
the full employment level. When GDP increases over two
years disproportionately, the price level and GDP are
increasing.
Inflationary Gap
-
CL
LRAS
Q.)
1. full employment
level
2. full output level
3. natural rate of
unemployment
u
~
P2
SRAS
_____
,_ .,. _
pi ___ ___
_,_
,
AD
I
>
Y(F) Y 1
Page41
Rea l GDP
Macroeconomics
Do-Now
Please do this:
1. Draw two graphs.
a. one showing an economy in contraction/recession
b. one showing an economy in expansion/inflation
(hint: both start with an economy in long-run equilibrium,
(the long-run aggregate supply curve)
Page42
Macroeconomics
Do-Now
~L contraction/recession
expansion/inflation
fi~ L~P\~ t;,'f..A.S fiO
Page43
Lfl.A$
s~S
The ProductionFunction
We can summarize the relationship between the three
determinants and aggregate supply (AS) of real GDP as:
real GDP= F(labor +capital+
technology)
The function F means that there is a general relationship
between the three variables in the parentheses. It is safe to
assume that the higher the variables, the higher the real GDP,
and vice versa. We call this relationship the production
function because it tells us how much production (real GDP)
of goods and services can be obtained from a certain amount
of labor, capital, and technology inputs.
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