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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