Transcript Chapter 6 AD-AS in the Long Run and the Self

LONG RUN AGGREGATE SUPPLY
• the amount of real output
• the economy is able to supply
• at different price levels
• if the economy is at Natural Real
GDP
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NATURAL REAL GDP
• the amount of output
• the economy could produce
• if it operated at full employment
• called Qn or Qf
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LONG RUN AGGREAGATE SUPPLY
LRAS
• vertical line
• at full employment Real GDP
• Qn = Qf
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THREE POSSIBLE STATES OF THE
ECONOMY
• Full employment equilibrium
• Recessionary gap
• Inflationary gap
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FULL EMPLOYMENT EQUILIBRIUM
The intersection of SRAS
and AD is equal to the
Natural Real GDP
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FULL EMPLOYMENT OUTPUT
(other terms)
• Potential GDP
• the Natural Rate of Employment
• the Natural Rate of
Unemployment
• QF or QN
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FULL EMPLOYMENT EQUILIBRIUM
PRICE LEVEL
LRAS
SRAS
AD
Qn
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REAL GDP
RECESSIONARY GAP
• Short run equilibrium output is
less than full employment
• People are not spending enough
to purchase all that has been
produced (inventories increase)
• unemployment is a concern
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RECESSIONARY GAP
LRAS
PRICE LEVEL
SRAS
AD
Q1
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Qn
REAL GDP
POLICY IMPLICATIONS OF A
SELF REGULATING ECONOMY
• Recessionary gaps are
eliminated by decreases in
wages and other input prices
• Graphically this is an increase in
SRAS
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Self-Regulating Economy
Price Level
Exhibit 2 (1 of 2)
Part (a)
SRAS1
The economy is in a
recessionary gap at
point 1.
1
P1
AD1
0
5,200 6,000
Unemployment rate
is higher at $5,200
billion than at $6,000
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billion
Suppose
this is
Natural
Real GDP
Real GDP
(billions of
base-year
dollars)
Self-Regulating Economy Exhibit 2 (2 of 2)
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INFLATIONARY GAP
• Equilibrium output is greater
than full employment output
• People are spending more than
businesses anticipated and
inventories are being drawn
down
• Inflation is a major concern
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INFLATIONARY GAP
Price Level
LRAS
SRAS
Short-run
equilibrium
Long-run
equilibrium
AD
0
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QN
Natural
Real GDP
POLICY IMPLICATIONS OF A
SELF REGULATING ECONOMY
• Inflationary gaps are eliminated
by increases in wages and input
prices
• Graphically, this is a decrease in
SRAS
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Self-Regulating Economy:
Removing an Inflationary Gap
Price Level
Exhibit 3 (1 of 2)
Part (a)
SRAS1
1
P1
0
6,000
Suppose this is
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6,500
The economy is in an
inflationary gap at
point 1.
AD1
Real GDP
(billions of
base-year
dollars)
Unemployment rate is
lower at $6,500 billion
than at $6,000 billion
Self-Regulating Economy:
Removing an Inflationary Gap
Exhibit 3 (2 of 2)
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CLASSICAL ECONOMIC REASONING
• Inflationary and Recessionary
gaps will be automatically
eliminated due to
– flexible prices
– flexible wages
– flexible interest rates
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CLASSICAL VIEW OF THE PRODUCT
MARKET
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SAY’S LAW
SUPPLY CREATES ITS OWN
DEMAND
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REASONING BEHIND SAY’S LAW
• People don’t work just to earn
money. They work for the things
that money can buy.
• People don’t save just to hold
the money. They save in order to
invest.
• All that is earned will be spent.
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