1. Macroeconomics – Unit 3 part 5

2. PL Q=realGDP=Y AD LRAS PL 1 YFYF SRAS Y1Y1 Short Run Equilibrium occurs where _____ & _____ intersect & then you determine the _____ & _____ for the economy. AD SRAS PL Y 2 of 14

3. Short-Run Equilibrium PL Q=realGDP=Y SRAS PL 1 PL 2 Q1Q1 Q2Q2 AD Q3Q3 What is going on in the economy if PL is at P 2 ? aggregate demand ________ aggregate supply  firms experience reduction of ____________  firms increase __________ & ___________ bringing output towards - equilibrium level. exceed s inventories production employment

4. Long Run Equilibrium – where SRAS, AD & LRAS intersect. PL Q=realGDP=Y LRAS Y When the economy is in long run equilibrium, aggregate demand grows at the same rate as potential output, so there are no pressures on the economy to raise prices or reduce production, etc. Growth and employment are at target rates and inflation is minimal. AD SRAS

5. Recessionary Gap – amount by which the short run equilibrium is below potential output PL Q=realGDP=Y LRAS YFYF So what must happen to bring the economy to long run equilibrium ? AD SRAS Y1Y1 PL 1 What is the value of the recessionary gap on this graph? Y F – Y 1

6. Recessionary Gap – could be fixed by... PL Q=realGDP=Y LRAS YFYF AD SRAS Y1Y1 PL 1 (1) shift in SRAS – b/c economy is producing at a level ________ potential output, below __________ are sitting around unused  costs and wages tend to _____  price level falls and SRAS shifts _____ until equilibrium. resources fall right theoretically, that is.... SRAS 2

7. Recessionary Gap – could be fixed by... PL Q=realGDP=Y LRAS YFYF AD SRAS Y1Y1 PL 1 (2) shift in AD – much more often what happens is... the Government uses fiscal taxes policy or monetary policy to stimulate or slow down economy. Fiscal policy – deliberate change in _____ or government ________ to expand or contract AD. spending AD 2 PL 2 7 of 14

8. Inflationary Gap –amount by which the aggregate expenditures (AD) are above potential output. PL Q=realGDP=Y LRAS YFYF How is it possible to produce beyond potential resources? AD SRAS Y2Y2 PL 1 What is the value of the inflationary gap on this graph? Y 2 – Y F Extra shifts, machinery run 24 hours, but workers become exhausted & machinery wears out; output must return to its potential

9. Inflationary Gap – could be fixed by... (1) shift in SRAS – b/c economy is producing at a level ________ potential output, above there is a huge demand for ________  costs and wages _____  price level rises and SRAS shifts _____ until equilibrium. resources rise left theoretically, that is.... PL Q=realGDP=Y LRAS YFYF AD SRAS Y1Y1 PL 1 SRAS 2 PL 2

10. Inflationary Gap – could be fixed by... fiscal PL Q=realGDP=Y LRAS YFYF AD SRAS Y1Y1 PL 1 AD 2 PL 2 (2) shift in AD – much more often what happens is... the Government uses _______ ________ or ________ policy to stimulate or slow down economy. Here gov’t would increase _____ or cut _______ to get AD to shift left. policy monetary taxes spending

11. Sample problem...starting economy at full employment...price is ___ and output is ___. P0P0 The exchange rate falls dramatically making exports ________  _____ shifts ______  PL _______ & output _________. increase ADright PL Q=realGDP=Y LRAS YFYF AD 1 SRAS Y1Y1 PL 1 AD PL 0 YFYF rises increases 11 of 14

12. But next you have long-term adjustment... (assuming the gov’t hasn’t stepped in with fiscal or monetary policy) PL Q=realGDP=Y LRAS YFYF AD 1 SRAS Y1Y1 PL 1 SRAS 2 PL 2 AD PL 0 There is a huge demand for __________ & with a higher PL labor pushes for higher _______  costs and wages _____  price level rises and SRAS shifts _____ until equilibrium. But now new equilibrium is at the ______ output, but ______ Price Level. resources rise lef t wages highe r same

13. This is called long-term adjustment. It assumes no intervention by the ____________. On an AP free response question or IB question, you would be expected to correctly graph that process as well as explain it verbally. government

14. Classwork AP workbook p. 143-146, Activity 28 15 min 14 of 14