Download Price Level

Moving from the Short
Run to the Long Run
1
Shifts in AD or AS change the price level and
output in the short run
Price
Level
LRAS
AS
PLe
AD
QY
GDPR
2
Example: Assume consumers increase
spending. What happens to PL and Output?
Price
Level
LRAS
AS
PL1
PLe
AD
QY Q1
AD1
GDPR
3
Now, what will happen in the LONG RUN?
Inflation means workers seek higher wages and
production costs increase
LRAS AS1
Price
Level
AS
PL2
Back to full
employment with
higher price level
PL1
PLe
AD
QY Q1
AD1
GDPR
4
Example: Consumer expectations fall and
consumer spending plummets. What happens to PL
and Output in the Short Run and Long Run?
Price
Level
LRAS
AS
AS1
AS increases as
workers accept lower
wages and production
costs fall
PLe
PL1
PL2
AD1
Q1 QY
AD
GDPR
5
Movements in the LRAS curve
1. Increases in quantities of factors of production
For example, an increase in the quantity of physical capital,
or land (eg. discovery of oil reserves) - the economy is
capable of producing more real GDP.
2. Reductions in the natural rate of unemployment
3. Improvements in technology
This means that factors of production can produce more
output. Eg: improved machines and equipment due to
technological advances
4. Improvements in the quality of factors of production
Eg: greater level of education, skills or health.
The Car Analogy
The economy is like a car…
• You can drive 120mph but it is not sustainable.
(Extremely Low unemployment)
• Driving 20mph is too slow. The car can easily go faster.
(High unemployment)
• 70mph is sustainable. (Full employment)
• Some cars have the capacity to drive faster then others.
(industrial nations vs. 3rd world nations)
• If the engine (technology) or the gas mileage
(productivity) increase then the car can drive at even
higher speeds. (Increase LRAS)
The government’s job is to brake or speed up when
needed as well as promote things that will improve the
engine. (Shift the PPC outward)
7
How does the Government Stabilizes the
Economy?
The Government has
two different tool
boxes it can use:
1. Fiscal PolicyActions by Congress to
stabilize the economy.
OR
2. Monetary PolicyActions by the
Federal Reserve Bank
to stabilize the
economy.
8