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Aggregate Equilibrium Macroeconomic Theory LRAS1 Price Level P1 ----------------- SRAS1 E1 AD1 Y1 Real GDP Recessionary Gap Inflationary Gap Economy below full output Economy above full output LRAS1 Price Level SRAS1 Price Level ----------- E1 --------- P1 Y1 AD1 Y* Real GDP Unemployment high, real output low Below PPF, Actual Px level < Expected ----------------- -------------- P1 LRAS1 1 Y* Y SRAS1 E1 AD1 Real GDP Unemployment very low, output high Above PPF, Actual Px level > Expected Short Run Equilibrium • In short run, a shift in AD will cause changes in real GDP, Unemployment & price level • Reason: Prices & Wages are sticky – expected price level LAGS actual price level – This allows recessionary & inflationary gaps Note: you are graphing actual price level Long Run Equilibrium • In long run, AD shifts do not affect real output (or employment) – Prices/wages become perfectly flexible in long run – Actual price level must equal expected price level – Will always be at full potential output (full employment) LRAS1 Price Level P1 ----------------- SRAS1 E1 AD1 Y1 Real GDP LONG RUN EQUILIBRIUM LRAS1 Price Level P1 IN A LONG RUN EQUILIBRIUM: SRAS1 3 Things must be true: ----------------- 1) Expected Price Level = Actual Price Level E1 AD1 Y1 2) Employment = Full Employment 3) Real GDP = Full Potential Output (on PPF) Real GDP Equation from Textbook (you do not need to understand this….) Quantity Supplied = Natural rate of Output + a( Actual Px ( Level Expected Px) Level ) Manipulating AD/AS Worksheet SRAS1 Price Level P1 ------------- E1 ------------- P1 Y1 LRAS1 Price Level ----------------- E1 AD1 AD1 Real GDP SRAS1 Y1 Real GDP Example: Stock Market Crash 2- causes output to fall in short run . . . Short run —Step 1 & 2 Price Level Long Run– Step 3 & 4 LRAS SRAS1 SRAS2 3. . . . but over time, SRAS shifts as expected level falls .Price . A P B P2 1-Decrease in AD P3 C AD1 AD2 0 Y2 . Real GDP Y 4. . . . and output returns to its natural rate.
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