Transcript Positive demand shock. - University High School

National Income and Price
Determination: Equilibrium
in AD/AS Model
AP Economics
Mr. Bordelon
S
SR Macroeconomic
Equilibrium
When APL is above
intersection of AD and
SRAS, at ESR, there is a
surplus of aggregate output
in the economy. When
there is a surplus of output,
prices begin to fall.
When APL is below
intersection of AD and
SRAS, at ESR, there is a
shortage of aggregate
output in the economy.
Where there is a shortage
of output, prices begin to
rise.
The AD/AS model
assumes that the economy
is in a state of short-run
equilibrium (SRE).
Shifts of AD
Shifts of AD
Events that shift AD are
called demand shocks.
Positive demand shock.
Assume that the stock
market has increased
consumer wealth. The
increase in wealth
would cause AD to shift
right. APL and real
GDP increase.
Shifts of AD
Negative demand
shock. Assume that
consumers and firms
become pessimistic
about future income
and future earnings.
AD shifts left. APL
and real GDP decrease.
Recession. Plagues.
Locusts.
Shifts of SRAS
Shifts of SRAS
Events that shift SRAS
are called supply
shocks.
Positive supply shock.
Assume that labor
productivity increased
with better technology.
SRAS shifts right. APL
decreases and real GDP
increases.
Shifts of SRAS
Negative supply shock.
Assume commodity
prices rapidly increased.
SRAS shifts left. APL
increases and real GDP
decreases. This is also
known as stagflation.
AP Note: This is a
commonly tested item.
Know this, understand it,
because if you can
explain the problems that
arise from stagflation,
you understand the
AD/AS model in the
long-run.
Long-Run Equilibrium
Long-Run Equilibrium
S The AD/AS model predicts that in the long run, when all
prices are flexible (remember, all fixed costs become variable
costs in the long-run), that the AD, SRAS, and LRAS curves
will intersect at LRE, at potential output YP.
S For the most part, this is an examination of fiscal policy and
demand shocks. You will learn later, there is little fiscal
policy can do regarding supply shocks.
LRE
Positive demand shock.
Assume that AD increases
and shifts right. In short
run, real GDP and APL
increases. The amount
GDP increases above YP is
called an inflationary gap.
Labor market is
strengthened by a booming
economy and
unemployment decreases as
workers are hired. Nominal
wages rise. As nominal
wages rise, SRAS shifts left.
Inflation gap falls because
real GDP falls. Once real
GDP returns to YP, the
economy is in LRE. APL
increased.
LRE
Negative demand shock.
Assume that AD decreases
and shifts left. In short run,
real GDP and APL
decrease. The amount GDP
decreases below YP is called
a recessionary gap.
Labor market is weakened
by a poor economy and
unemployment begins to
rise as workers are laid off.
Nominal wages decrease.
As nominal wages decrease,
SRAS shifts right.
Recessionary gap decreases
because real GDP increases.
Once real GDP returns to
YP, economy is in LRE.
APL has decreased.
LRE
S Whenever the economy is out of LRE, there is either a recessionary
or an inflationary gap. This output gap can be measured as a
percentage between YP and current real GDP.
S
Output gap = (Y1 – YP)/YP x 100%
S Recessionary gap. Output gap is negative, nominal wages decrease,
economy moves to YP and output gap returns to zero.
S Inflationary gap. Output gap is positive, nominal wages increase,
economy moves to YP and output gap returns to zero.
S Self-correcting. In the long run, the economy is self-correcting.
Shocks to AD affect aggregate output in short run, but not long run.
Question 1
S Use AD/AS graphs to show short-run effects of each of the
following shocks on APL and aggregate output.
S Price of copper, steel, and other commodities has risen in global
markets.
S A weak auto industry has prompted less investment spending by
many firms that manufacture auto parts (brake pads, fan belts,
spark plugs, etc.).
S Congress lowers taxes and increases spending.
S More and more students are graduating from high school and
receiving college degrees. (Assume that a more educated
workforce is a more productive workforce).
Question 2
S Draw a graph that shows the economy currently in LRE.
S Suppose that household wealth has been falling for several
months. Given this, adjust your graph to show both the shortrun change in APL and real GDP.
S Describe how the economy will adjust in the long run. Show
in your graph this adjustment to LRE. Use complete
sentences.