Transcript 3.3 Macroeconomic models

2.2 AGGREGATE DEMAND AND AGGREGATE SUPPLY
1. Distinguish between the microeconomic concept of demand for a product and
the macroeconomic concept of aggregate demand
The microeconomic demand curve
has the “price” of the one good on
the y-axis, the macroeconomic
aggregate demand curve has a
measure of the average price level
of all goods and services.
Where the microeconomic demand
curve has the “quantity” of the one
good on the x-axis, the
macroeconomic aggregate demand
curve has The total quantity of all
goods and services, which is national
output. (Real GDP)
.
Define aggregate demand
AGGREGATE DEMAND:
The total (or aggregate) real expenditures on final
goods and services produced in the domestic economy
that buyers would willing and able to make at different
price levels, during a given time period (usually a year).
Aggregate demand (AD) relates the economy's price
level, measured by the GDP price deflator, and
aggregate expenditures on domestic production,
measured by real gross domestic product.
The aggregate expenditures are consumption,
investment, government purchases, and net exports made
by the four macroeconomic sectors (household, business,
government, and foreign).
2. Construct an aggregate demand curve.
The aggregate demand
curve
The AD curve shows the
relationship between AD
and the price level.
It is assumed that the AD
curve will slope down from
left to right.
This is because all the
components of AD, except
imports, are inversely
related to the price level.
3. Explain why the AD curve has a negative slope.
Trade, liquidity and wealth effects
The AD curve slopes down because the components of AD are
inversely related to the price level.
There are three main effects to consider:
1. The price level and international trade – the ‘trade’
effect
A rise in domestic prices makes exports less competitive and
imports more competitive; hence exports (X) are likely to fall
and imports (M) are likely to rise.
Both of these reactions combine to create a trade effect, with
lower aggregate demand at the higher price level.
3. Explain why the AD curve has a negative slope.
2. The price level and liquidity – the ‘liquidity/interest rate’ effect
When the price level increases, households and firms need to spend more
money to continue to consume the scarce resources they need.
This makes them relatively ‘short of cash’ than they were at the lower price
level.
The liquidity of an asset refers to how easily it is converted to cash, with cash
itself being ‘perfectly liquid’.
The loss of liquidity associated with a rise in the price level forces some
households and firms to borrow from banks, which reduces the liquidity of
banks.
In response, banks are likely to raise interest rates as compensation for this
lost liquidity. The banks need to keep a certain amount of their reserves in a
highly liquid form to meet any unexpected increase in demand for cash.
As a result of the lost liquidity, interest rates are forced to rise, and both
household and corporate spending may fall. Hence, aggregate demand is
lower at the higher price level.
3. Explain why the AD curve has a negative slope.
3. The price level and the value of wealth – the ‘wealth’ effect
Given that interest rates will rise as financial markets readjust to
the higher price level, there are likely to be further ‘knock on’
effects on household (and corporate) wealth.
Higher rates may lead to a fall in house prices, or at least slowdown house price inflation, and create a negative wealth effect.
Rising interest rates tend to reduce corporate profits and reduce
share values - again creating a negative wealth effect.
A lower price level will, of course, have the reverse effect, that is
to create a positive wealth effect on AD.
The combined effect of these wealth effects is to alter consumer
and corporate spending, and hence alter the level of AD.
4. Describe consumption, investment, government spending
and net exports as the components of aggregate demand.
Aggregate demand consists of
the amount households plan
to spend on goods (C), plus
planned spending on capital
investment, (I) + government
spending, (G) + exports (X)
minus imports (M) from
abroad. The standard
equation is:
AD = C + I + G + (X – M)
Aggregate demand can be
illustrated by reference to the
circular flow of income:
5. Explain how the AD curve can be shifted by changes in consumption due to factors
including changes in consumer confidence, interest rates, wealth, personal income taxes
(and hence disposable income) and level of household indebtedness.
Determinates of Household spending
(Consumption)
 consumer
confidence
 interest rates
 Wealth
 personal income taxes (and hence
disposable income)
 level of household indebtedness.
6. Explain how the AD curve can be shifted by changes in investment
due to factors including interest rates, business confidence, technology,
business taxes and the level of corporate indebtedness.
Determinates of Investment Spending
 interest rates
 business confidence
 Technology
 business taxes
 the level of corporate indebtedness
7. Explain how the AD curve can be shifted by changes in
government spending due to factors including political and
economic priorities.
Determinates of Government Spending
Political priorities
economic priorities
8. Explain how the AD curve can be shifted by changes in net exports due to
factors including the income of trading partners, exchange rates and changes in
the level of protectionism.
Determinates of Net Exports Spending
income of trading partners
 exchange rates
 changes in the level of protectionism

9. Define the term aggregate supply.
Aggregate supply (AS) is defined as the total amount
of goods and services (real output) produced and
supplied by an economy’s firms over a period of time.
It includes the supply of a number of types of goods
and services including private consumer goods, capital
goods, public and merit goods and goods for overseas
markets.
At higher price levels across the economy firms expect
that they can sell their final products at higher prices,
and there will be a positive relationship between the
price level and aggregate supply.
10. Explain, using a diagram, why the short-run aggregate supply
curves (SRAS Curve) is upward sloping
Short run aggregate supply (SRAS) shows total planned
output when prices in the economy can change but the
prices and productivity of all factor inputs e.g. wage rates
and the state of technology are held constant.
In the short run, the SRAS curve is assumed to be upward
sloping (i.e. it is responsive to a change in aggregate
demand reflected in a change in the general price level)
The up sloping SRAS curve indicates a direct
relationship between the price level and the amount of
real output that firms will offer for sale.
10.Explain, using a diagram, why the short-run aggregate
supply curves (SRAS Curve) is upward sloping
11. Explain, using a diagram, how the AS curve in the short run (SRAS) can
shift due to factors including changes in resource prices, changes in
business taxes and subsidies and supply shocks.
Changes in Input Prices
Domestic
Resource Availability
(Land, Labor, Capital & Entrepreneurial
ability)
Prices of Imported Resources
Market Power
11. Explain, using a diagram, how the AS curve in the short run (SRAS) can
shift due to factors including changes in resource prices, changes in
business taxes and subsidies and supply shocks.
Changes in Productivity
 technology
Changes in Legal-institutional
Environment (LIE)
 Business
Taxes and Subsidies to Businesses
 Government Regulations
11. Explain, using a diagram, how the AS curve in the short run (SRAS) can shift
due to factors including changes in resource prices, changes in business taxes and
subsidies and supply shocks.
A change in
aggregate supply
is caused by any
factor affecting
supply EXCEPT the
price level.
Illustrate aggregate demand and shifts in aggregate demand
Shifts in AD
A change in any of the
components of aggregate demand
will cause a shift in the aggregate
demand curve.
 An increase in AD, such as that
caused by an increase in
household spending, is shown by
a rightward shift in the whole AD
curve.
 The shift in demand will have an
effect on the price level and
national output, but the effects
may not be uniform because
aggregate supply (AS) may not
be linear.
12. Explain, using a diagram, that the monetarist/new classical model of the long-run
aggregate supply curve (LRAS) is vertical at the level of potential output (full employment
output) because aggregate supply in the long run is independent of the price level.
Aggregate supply
There is some dispute between Keynesians and
Monetarists about what determines the level of
aggregate supply.
Keynesians argued that supply was determined by
the level of aggregate demand, while classical
(economists followed Say's Law which argued that
aggregate supply was determined by supply-side
factors.
12. Explain, using a diagram, that the monetarist/new classical model of the long-run
aggregate supply curve (LRAS) is vertical at the level of potential output (full employment
output) because aggregate supply in the long run is independent of the price level.
The gradient of the AS curve
Different theories of the shape of the AS curve arise
from different explanations about how real output
responds to changes in aggregate demand.
The Classical view:
The Classical view of real output was that it was fixed at a
particular level.
At this level, all the factors of production in the
economy would be fully employed.
Changes in AD will only bring about changes in the
price level, not the level of real output.
12. Explain, using a diagram, that the monetarist/new classical model of the long-run
aggregate supply curve (LRAS) is vertical at the level of potential output (full employment
output) because aggregate supply in the long run is independent of the price level.
A neo-classical long run
aggregate supply (LRAS) is
perfectly inelastic at the level of
potential output (full
employment level of output).
They believe that the potential
output of the economy is
dependent on the quantity and
quality (productivity) of the
factors of production, not on the
price level.
Thus the LRAS curve is
independent of the price level.
neo-classical
Classical theories revolved mainly around the role of
markets in the economy.
If markets worked freely and nothing prevented their
rapid clearing then the economy would prosper.
Any imperfections in the market that prevented this
process should be dealt with by government.
The main roles of government are therefore to ensure
the free workings of markets using 'supply-side
policies' and to ensure a balanced budget.
13. Explain, using a diagram, that the Keynesian model of the aggregate supply
curve has three sections because of “wage/price” downward inflexibility and
different levels of spare capacity in the economy.
Keynesian LRAS: shows three possible phases:
 In the horizontal range there is low levels of economic
activity. There is excess capacity so very little price
pressure and high unemployment.
 In the upper sloping range, the economy is approaching
full employment so there is price pressure and increase
in output so lower unemployment.
 In the vertical range, the economy is at full employment
and it’s impossible to increase output. All price pressure.
Keynesian
13. Explain, using a diagram, that the Keynesian model of the aggregate supply
curve has three sections because of “wage/price” downward inflexibility and
different levels of spare capacity in the economy.
1.
2.
3.
The Sticky-Wage Theory: An unexpectedly low price
level raises the real wage, which causes firms to hire
fewer workers and producer a smaller quantity of
goods and services.
The Sticky-Price Theory: An unexpectedly low price
level leaves some firms with higher-than-desired prices,
which depresses their sales and leads them to cut back
production.
The Misperceptions Theory: An unexpectedly low price
level leads some suppliers to think their relative prices
have fallen, which induces a fall in production.
13. Explain, using a diagram, that the Keynesian model of the aggregate
supply curve has three sections because of “wage/price” downward
inflexibility and different levels of spare capacity in the economy.
When the demand for labor falls (maybe due
to the onset of a recession), the wage rate
should fall, so that the market clears.
However, Keynes argued that because wages
were sticky downwards, this would not
happen and unemployment would persist.
This unemployment he termed demand
deficient unemployment
13. Explain, using a diagram, that the Keynesian model of the aggregate supply curve has
three sections because of “wage/price” downward inflexibility and different levels of spare
capacity in the economy.
Keynes argued that
relying on markets to
get to full employment
was not a good idea.
He believed that the
economy could settle
at any equilibrium and
that there would not
be automatic changes
in markets to correct
this situation.
13. Explain, using a diagram, that the Keynesian model of the aggregate supply curve has
three sections because of “wage/price” downward inflexibility and different levels of spare
capacity in the economy.
A “Keynesian” long run aggregate supply
14. Compare and contrast, using the two models above, the way that factors leading to changes in the
quantity and/or quality of factors of production (including improvements in efficiency, new technology,
reductions in unemployment, and institutional changes) can shift the aggregate supply curve over the
long term.
Shifts in long-run aggregate supply curve are usually gradual and
anticipated, unlike shifts in the SRAS which can be dramatic and
unanticipated. LRAS can shift for many reasons, including:
1. The level of spending on new, technology which enables an economy to
produce in greater volume or improved quality - even using the same
quantity of scarce resources.
2. Long term inward investment from abroad, which enables increased
production. Inward investment, like domestic investment, increases an
economy’s productive capacity.
3. Migration and population growth, which increases the quantity of human
capital.
4. Education and training, which increases the quality of human capital.
5. Competition in product and labor markets, which improves efficiency and
productivity.
6. Effective supply-side policy, which creates the right environment for
households to supply factors of production and for firms to produce output.
14. Compare and contrast, using the two models above, the way that factors leading to changes in the
quantity and/or quality of factors of production (including improvements in efficiency, new technology,
reductions in unemployment, and institutional changes) can shift the aggregate supply curve over the
long term.
long-run aggregate supply curve
15. Explain, using a diagram, the determination of short-run
equilibrium, using the SRAS curve.
Shifts of the short-run aggregate supply curve can be
brought about by such things as technology, changes in
wages and other resource prices, or changes in resource
quantities.
While changes in aggregate supply determinants and
resulting shifts of the short-run aggregate supply curve
are less dramatic than changes affecting aggregate
demand, they DO change.
In most cases the changes are slow and steady.
15. Explain, using a diagram, the determination of
short-run equilibrium, using the SRAS curve.
Illustrate short-run aggregate supply
Short Run Aggregate Supply
Curve – Classical
In the short run an increase in
aggregate demand may lead to an
increase in output, but there will
also be an increase in the price
level.
As firms realize that there has not
been a real increase in demand,
they will once again reduce output
and the economy will tend back to
the full employment level of output.
Illustrate short-run aggregate supply
Keynesian Aggregate
Supply
Keynes argued that in
the long run, the
economy can settle at an
equilibrium below the full
employment level of
output. As a result, the
AS curve looks like this.
16. Examine, using diagrams, the impacts
of changes in short-run equilibrium.
Short-run aggregate market equilibrium means the economy has no
wide-spread shortages or surpluses in the product markets.
However, this does not necessarily mean that ALL product markets are
in equilibrium.
A complex economy, like that in the United States, is bound to have
shortages in some product markets and surpluses in others in short-run
equilibrium.
As such, prices in some markets rise, while those in other markets fall.
These sorts of imbalances in specific markets reflect the ongoing
reallocation of resources at the microeconomic level.
What is required for aggregate market equilibrium at the
macroeconomic level is that the microeconomic shortages and
surpluses cancel out, that rising prices cancel falling prices, that the
price level and real production do not change.
16. Examine, using diagrams, the impacts
of changes in short-run equilibrium.
Macro-equilibrium is
when the quantity of real
GDP demanded equals
the quantity of real GDP
supplied.
Full employment Macroequilibrium is where
SRAS intersects AD on the
LRAS curve.
16. Examine, using diagrams, the impacts of
changes in short-run equilibrium.
Short-run equilibrium
output
Is when Aggregate
Demand is equal to the
short –run Aggregate
Supply
Long-run
equilibrium output
The Long-run
equilibrium is where
the aggregate demand
is equal to long-run
aggregate supply.
17. Explain, using a diagram, the determination of long-run equilibrium,
indicating that long-run equilibrium occurs at the full employment level of
output.
Full employment level of national income:
This is the level at Net National Income at which
everyone who wants to work is able to.
There is in other words sufficient demand to employ
everyone. Classical economists argued that the
economy would automatically tend to this equilibrium,
whereas Keynesians said that it was the role of
government, through their policy, to ensure we got
there.
17. Explain, using a diagram, the determination of long-run equilibrium, indicating
that long-run equilibrium occurs at the full employment level of output.
17. Explain, using a diagram, the determination of long-run equilibrium,
indicating that long-run equilibrium occurs at the full employment level of
output.
The LRAS will shift if there
are changes in the quantity
and/or quality of factors
of production (including
improvements in efficiency,
new technology, reductions
in natural unemployment,
and institutional changes)
The LRAS curve is the same
as the Production
Possibilities Curve or
Potential GDP Curve.
18. Examine why, in the monetarist/new classical approach, while there
may be short-term fluctuations in output, the economy will always return to
the full employment level of output in the long run.
The Classical economists assumed that if the economy was left to itself,
then it would tend to full employment equilibrium. This would happen if
the labor market worked properly. If there was any unemployment, then the
following would happen:
Unemployment
labor
Fall in wages
Increase demand for
equilibrium restored at full employment
Classical economists had complete faith in markets. They believed that the
economy would always settle - automatically - at the full employment
equilibrium in the long-run. Due to flexible prices and wages. However,
they did acknowledge that there might be a slightly different reaction in the
short run as the economy adjusted to its new long-run equilibrium.
18. Examine why, in the monetarist/new classical approach, while there may be
short-term fluctuations in output, the economy will always return to the full
employment level of output in the long run.
19. Examine, using diagrams, the impacts
of changes in the long-run equilibrium.
Classical economists believe
that in the long run the economy
will settle automatically at the
full employment level of
income.
If something happens to increase
the full employment potential of
the economy, this will shift the
LRAS curve to the right.
Possible causes could be an
increase in productivity, an
improvement in skill levels or a
change in the tax and benefits
system.
20. Explain, using the Keynesian AD/AS diagram, that the economy
may be in equilibrium at any level of real output where AD
intersects AS.
Keynes argued that relying on markets to get to full
employment was not a good idea.
He believed that the economy could settle at any equilibrium
and that there would not be automatic changes in markets to
correct this situation.
He argued that wages would be 'sticky downwards'. In other
words workers would not be happy about taking wage cuts and
would resist this.
This would mean that wages would not necessarily fall enough
to clear the market and unemployment would linger.
This unemployment he termed demand deficient unemployment.
20. Explain, using the Keynesian AD/AS diagram, that the
economy may be in equilibrium at any level of real output where
AD intersects AS.
Keynes didn't distinguish
between the short-run and the
long-run as Classical economists
tend to.
He argued that the economy
could settle at any equilibrium
level of income at any time,
and it was the government job
to use appropriate policies to
ensure that this equilibrium was
a good one for the economy.
21. Explain, using a diagram, that if the economy is in equilibrium at a
level of real output below the full employment level of output, then
there is a deflationary (recessionary) gap.
A deflationary gap exists when there is insufficient
demand available in the economy to generate a fullemployment equilibrium. In other words there is not
enough being bought to provide jobs for everyone who
wants them.
Deflationary or recessionary or under full employment
gap, where planned expenditure is less than the full
employment level of income. Occurs where AD intersects
the SRAS curve at a level of real GDP that is below
LRAS.
21. Explain, using a diagram, that if the economy is in equilibrium at a level of real
output below the full employment level of output, then there is a deflationary
(recessionary) gap.
22. Discuss why, in contrast to the monetarist/new classical model, the economy can
remain stuck in a deflationary (recessionary) gap in the Keynesian model.
Keynesian economists believe that free markets are volatile and not self correcting.
Free market volatility:
• The free-market system is naturally prone to periods of recession & depression
• The volatility of aggregate demand (AD = C+I+G+X-M) can be explained by
changes in consumer and business sentiment – also known as animal spirits.
• In a world of stagnation or depression direct intervention in the economy may be
essential
Free markets are not always self-correcting:
• When a recession or a depression occurs, the free market system is not
necessarily self-correcting – indeed en-masse, individuals can become trapped in
a deflationary depression which is in no one’s interest but which, left on our own,
no one can counter-act.
• Persistent deflation can be as costly as high inflation – it can be damaging
especially in economies where there is a huge level of private & public sector
debt
• You cannot always rely on new inventions / innovations and other natural
stabilizers to drag an economy out of a recession
23. Explain, using a diagram, that if AD increases in the vertical section of the AS
curve, then there is an inflationary gap.
Inflationary or over employment gap, where planned
expenditure is greater than the full employment level of
income. Occurs where AD intersects the SRAS at a level of
real GDP that is above LRAS.
Inflationary gap: This occurs when there is too much
demand in the economy. This excess level of demand will
tend to lead to demand-pull inflation.
23. Explain, using a diagram, that if AD increases in the vertical
section of the AS curve, then there is an inflationary gap.
24. Discuss why, in contrast to the monetarist/new classical model, increases in aggregate
demand in the Keynesian AD/AS model need not be inflationary, unless the economy is
operating close to, or at, the level of full employment.
The economy could settle below full employment. Clearly this is not a very desirable
equilibrium as the level of output is very low and there would be high levels of unemployment.
Thus any increase in AD would not bring about any price level pressure as long as there was
excess capacity.
Nevertheless this situation could, according to Keynes, persist in the long-term unless the
government did something to stimulate the economy.
This something would have to be some sort of reflationary policy , which boosted the level of
aggregate demand.
As aggregate demand grows so does the level of output, but as the economy nears full
employment the dark specter of inflation emerges - in other words the price level starts to
increase! This inflation is due to an excess level of demand and so is called demand-pull
inflation .
At the same time there will be increased pressure on the labor market as nearly everyone has
a job, and so wages will begin to rise as firms have to offer more to get the people they want.
This in turn will cause costs to increase, and result in cost-push inflation.
24. Discuss why, in contrast to the monetarist/new classical model, increases in
aggregate demand in the Keynesian AD/AS model need not be inflationary, unless
the economy is operating close to, or at, the level of full employment.
25. Explain, with reference to the concepts of leakages (withdrawals) and injections,
the nature and importance of the Keynesian multiplier.
Multiplier:
The multiplier is concerned with how national income changes
as a result of a change in an injection, for example
investment.
The multiplier was a concept developed by Keynes that said
that any increase in injections into the economy (investment,
government expenditure or exports) would lead to a
proportionally bigger increase in National Income.
This is because the extra spending would have knock-on
effects creating in turn even greater spending.
The size of the multiplier would depend on the level of
leakages.
25. Explain, with reference to the concepts of leakages (withdrawals) and
injections, the nature and importance of the Keynesian multiplier.
Any increase in aggregate demand in the economy would result, according to
Keynes, in an even bigger increase in National Income.
This process came about because any increase in demand would lead to more
people being employed.
If more people were employed, then they would spend the extra earnings. This in
turn led to even more spending, which led to even more employment which led to
even more income which then led to even more spending which then led to .................
The length of time this process went on for would depend on how much of the extra
income was spent each time.
If the initial recipients of the extra income saved it all, then the process would stop
very quickly as no-one else would get their hands on the extra income. However, if
they spent it all the knock-on effects of the extra spending would carry on for some
time.
Therefore the higher the level of leakages, the lower the Multiplier would be.
25. Explain, with reference to the concepts of leakages (withdrawals) and injections,
.
the nature and importance of the Keynesian multiplier
26. Calculate the multiplier using either of the
following formulae.
Simply multiplier = 1/ (1-MPC) =1/MPS
Complex multiplier = 1/ (MPS + MPT + MPM)
Marginal propensity to consume(MPC): The proportion
of each extra dollar of disposable income spent by
households. For example, if a person earns 1 more and
consumes 60% of it, then the MPC is 0.6.
Marginal propensity to Save (MPS): The proportion of
each extra dollar of disposable income saved by
households.
26. Calculate the multiplier using either of the
following formulae.
1/(MPS + MPT + MPM) = Complex Multiplier
MPS = Marginal propensity to Save
MPT = Marginal propensity to Tax
MPM = Marginal propensity to Import
27. Use the multiplier to calculate the effect on GDP of a change in an
injection in investment, government spending or exports.
Calculating the value of the multiplier
The formal calculation for the value of the multiplier is
Multiplier = 1 / (sum of the propensity to save + tax + import)
Therefore if there is an initial injection of demand of say £400m and

The marginal propensity to save = 0.2

The marginal rate of tax on income = 0.2

The marginal propensity to import goods and services is 0.3
Then the value of national income multiplier = (1/0.7) = 1.43
An initial change of demand of £400m might lead to a final rise in GDP of 1.43 x £400m = £572m
If

The marginal propensity to save = 0.1

The marginal rate of tax on income = 0.2

The marginal propensity to import goods and services is 0.2
The value of the multiplier = 1/0.5 = 2 – the same initial change in aggregate demand will lead to a
bigger final change in the equilibrium level of national income. 2 x 400m = 800m
28. Draw a Keynesian AD/AS diagram to show the
impact of the multiplier.
Explain the Accelerator effect of investment on national
income.
Accelerator:
The principle states that a given change in demand for consumer
goods will cause a greater percentage change in demand for
capital goods.
The principle is used to help explain business cycles.
The accelerator theory suggests that the level of net investment
will be determined by the rate of change of national income.
If national income is growing at an increasing rate then net
investment will also grow, but when the rate of growth slows net
investment will fall.
There will then be an interaction between the multiplier and the
accelerator that may cause larger fluctuations in the trade cycle.
2.2 Aggregate Demand and Aggregate Supply
Short-run equilibrium output
Is when Aggregate Demand is equal to the short –
run Aggregate Supply
Long-run equilibrium output
The Long-run equilibrium is where the aggregate
demand is equal to long-run aggregate supply.
2.2 Aggregate Demand and Aggregate Supply
Discuss the difference between Keynesian
(interventionist) and neo-classical (free market)
economist in the view of macroeconomic
equilibrium
 Keynesian view is that the equilibrium level may
occur at different levels and can be below full
employment levels. Their view is that the
government must intervene to steer the economy
toward full employment using demand-side
policies.
2.2 Aggregate Demand and Aggregate Supply

The neo-classical view is that the economy will
always move toward its long-run equilibrium at
full employment. Thus the long-run equilibrium is
where the AD meets the vertical LRAS curve. Any
changes to AD will only result in price level
changes, thus government intervention is not
needed.
2.2 Aggregate Demand and Aggregate Supply
Explain and illustrate that the difference between the
equilibrium level of national income and the full
employment level of national income will result in an
inflationary or deflationary gap.
When the short-run equilibrium is beyond the full
employment level you will have an inflationary gap.
When the short-run equilibrium is below the full
employment level you will have an deflationary gap.