Download Macroeconomic equilibrium

Macroeconomic equilibrium
Macroeconomic equilibrium occurs at the price level where aggregate demand equals
aggregate supply. This occurs where the AD curve intersects the SRAS curve.
Price Level
GDP Price
Deflator
SRAS
P1
AD
Y1
Output (Real GDP)
At any other price level in the economy there is disequilibrium. At a price level above
P1, there will be a surplus of goods and services and firms will have to reduce prices to
get rid of them.
Macroeconomic equilibrium and full employment
As you already know, macroeconomic equilibrium occurs where SRAS equals AD. This
may or may not coincide, however, with the full employment level of output. The
economy is at a level of full employment when macroeconomic equilibrium is on the
LRAS curve. This means that the economy is actually producing at its maximum
potential.
The Business Cycle and the AD/AS model
The figure below illustrates the Business/Trade Cycle. This is the periodic
fluctuations in economic activity measured by changes in real GDP. We can
generally see a pattern where there are periods of rising growth, followed by periods of
slowing growth. The actual real GDP is seen fluctuating around the long run potential
output over a period of years. In year two, for example, actual GDP is below full
employment real GDP level. The gap between actual output and full employment output
is known as a ‘recessionary gap’.
In Year 3 full employment equilibrium is obtained and then in year four actual GDP has
increased to nearly $200bn over full employment level. This difference is known as an
‘inflationary gap’.
The Business/Trade Cycle
Real GDP
(billions of
1999 $)
800
Inflationary gap
Long run potential GDP
600 Recessionary gap
400
Full employment
Actual real GDP
200
0
0
1
2Year
3
4
5
These three types of macroeconomic equilibrium can be shown on AD/AS models.
200
Price
Level
(GDP
Deflator
1999= 150
100)
LRAS
SRAS
Full employment equilibrium.
Full employment equilibrium
occurs where the SRAS curve
intersects the AD curve at the
level of full employment as
indicated by the LRAS curve.
100
50
AD
0
100 200 300 400 500 600 700 800 900
Real GDP (billions of 1999 US$)
200
Price
Level
(GDP
Deflator
1999= 150
100)
LRAS
Unemployment equilibrium.
SRAS
Unemployment
equilibrium
occurs where the SRAS curve
intersects the AD curve at an
output below the full employment
level of output- the difference
being called a ‘recessionary gap’
100
50
AD
0
100 200 300 400 500 600 700 800 900
Real GDP (billions of 1999 US$)
200
Price
Level
(GDP
Deflator
1999= 150
100)
SRAS
Above full employment equilibrium
occurs where the SRAS curve intersects
the AD curve at an output above the full
employment level of output- the
difference being called an ‘inflationary
gap’
100
50
0
Above full employment equilibrium.
100 200 300 400 500 600 700 800 900
Real GDP (billions of 1999 US$)