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Equilibrium By J.A. SACCO. Equilibrium Recall- Intersection of demand and supply * More complicated because of the two aggregate supply curves- but the.

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Presentation on theme: "Equilibrium By J.A. SACCO. Equilibrium Recall- Intersection of demand and supply * More complicated because of the two aggregate supply curves- but the."— Presentation transcript:

1 Equilibrium By J.A. SACCO

2 Equilibrium Recall- Intersection of demand and supply * More complicated because of the two aggregate supply curves- but the concept is the same If the price level – Excess quantity of real goods/services. AS>AD Result is suppliers drop the price which will create greater quantity of aggregate demand

3 3 Equilibrium Real GDP per Year ($ trillions) SRAS 10 LRAS AD Price Level At price level 140 AS>AD and the price level falls.

4 Equilibrium If the price level -Quantity of AD would be greater than quantity of AS. AD>AS Result is because of the shortage buyers will bid up price which will result in suppliers increasing the quantity supplied.

5 5 Equilibrium Real GDP per Year ($ trillions) SRAS 10 LRAS AD Price Level At price level 100 AD>AS and the price level increases.

6 6 Equilibrium Real GDP per Year ($ trillions) SRAS 10 LRAS AD Price Level At price level 120 AD=AS.

7 Two Types of Equilibrium What is the state of the economy in the model to the right? What is meant by long run equilibrium? Draw an example? What is meant by short run equilibrium? Draw an example? Which equilibrium is most important? If the economy is at full equilibrium, this doesn’t mean the economy will stay there. Economic “shocks” occur that may shift the curves.

8 8 Consequences of Changes in Aggregate Supply and Demand Shift in curves. The effect is the price level or real GDP may change or both. Gives insight into inflation or recessions. Aggregate Demand Shock ▫Any shock that causes the aggregate demand curve to shift inward or outward. Aggregate Supply Shock ▫Any shock that causes the aggregate supply curve to shift inward or outward. How does this effect the economy?

9 Consequences of Changes in Aggregate Supply and Demand Contractionary Gap ▫Exist whenever the equilibrium level of real national income is less than the full-employment level

10 AD The Effects of Stable Aggregate Supply and a Decrease in Aggregate Demand: The Contractionary Gap Real GDP per Year ($ trillions) 0 SRAS 7 LRAS AD 1 Price Level 120 E1E1 115 E2E2 6.8 Contractionary Gap

11 Consequences of Changes in Aggregate Supply and Demand Expansionary Gap ▫Exist whenever the equilibrium level of real national income is greater than the full- employment level

12 7 LRAS The Effects of Stable Aggregate Supply and an Increase in Aggregate Demand: The Expansionary Gap Real GDP per Year ($ trillions) 0 SRAS AD 1 Price Level 120 E1E1

13 7 LRAS AD 2 The Effects of Stable Aggregate Supply and a Increase in Aggregate Demand: The Expansionary Gap Real GDP per Year ($ trillions) 0 SRAS AD 1 Price Level E1E1

14 AD 2 7 LRAS The Effects of Stable Aggregate Supply and a Increase in Aggregate Demand: The Expansionary Gap Real GDP per Year ($ trillions) 0 SRAS Price Level AD 1 E1E E2E2 7.2 Expansionary Gap

15 Explaining Inflation: Demand-Pull or Cost-Push? Demand-Pull Inflation ▫Inflation caused by increases in aggregate demand not matched by increases in aggregate supply ▫Whenever the general level of prices rise because of continual increase in AD ▫Could occur when the amount of money in circulation increases faster than the growth of the economy

16 16 Demand-Pull Inflation AD 2 7 LRAS The Effects of Stable Aggregate Supply and an Increase in Aggregate Demand: Demand-Pull Inflation Real GDP per Year ($ trillions) 0 SRAS AD 1 Price Level 120 E1E1 125 E2E2 7.2 Intersection of AD2 and SRAS shows an increase in the price level.

17 17 Explaining Inflation: Demand-Pull or Cost-Push? Cost-Push Inflation ▫Inflation caused by a continually decreasing short- run aggregate supply curve. ▫Caused by an increase in costs of inputs which decreases SRAS. STAGFLATION!

18 18 Cost-Push Inflation SRAS 2 7 LRAS The Effects of Stable Aggregate Demand and a Decrease in Aggregate Supply: Supply-Side Inflation Real GDP per Year ($ trillions) 0 SRAS 1 AD 1 Price Level 120 E1E1 E2E

19 19 The Oil Price Shock of the 1970s SRAS LRAS Real GDP per Year ($ trillions) 0 SRAS 1 AD 1 Price Level 115 E1E1 E2E SRAS shifted leftward due to the restrictions placed on the supply of oil to the U.S.

20 20 The Oil Price Shock of the 1970s Question ▫What would have happened to the LRAS if the price of oil had remained permanently high?


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