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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$) 200 Price Level (GDP Deflator 1999= 150 100) SRAS Above full employment equilibrium occurs where the SRAS curve intersects the AD curve at an output above the full employment level of output- the difference being called an ‘inflationary gap’ 100 50 0 Above full employment equilibrium. 100 200 300 400 500 600 700 800 900 Real GDP (billions of 1999 US$)