Equilibrium Equilibrium price and quantity are found where the AD and AS curves intersect. At any price level above equilibrium sellers are faced with surpluses and are forced to reduce production and price level. At any price level below equilibrium buyers are faced with shortages and are forced to pay more, encouraging suppliers to produce more.

Equilibrium Price Level Short-run aggregate supply Equilibrium A price Quantity of Output Price Level Short-run aggregate supply Aggregate demand A Equilibrium price Equilibrium output

Equilibrium In the short run equilibrium may be above or below the full employment rate. In other words AD and AS may not intersect at the LRAS. In the long run equilibrium will be at the LRAS, because in the long-run short run AS will have adjusted so that short-run aggregate output is equal to the potential output.

Short-run Equilibrium Below Full Employment Potential Output (recessionary gap) LRAS Price Level AS PL1 AD Q1 FE RGDP

Short run Equilibrium Above Full Employment Potential Output (inflationary gap) LRAS Price Level AS PL1 AD Q1 FE RGDP

Changes in AD Increases in AD cause the price level and the level of output and employment to rise. This rise in price level is known as demand-pull inflation. Decreases in AD cause the price level and the level of output and employment to fall. Increases or decreases in AD are known as Demand Shocks

Increases in AD LRAS Price Level AS PL2 PL1 AD2 AD Q1 FE ,Q2 RGDP

Increases in AS have a positive effect on both price level and output. Changes in AS Increases in AS have a positive effect on both price level and output. When AS shifts right, price levels fall or stabilize, but output increases.

Increases in AS LRAS Price Level AS AS1 PL PL1 AD FE Q1 RGDP

Changes in AS Decreases in AS have a negative effect on both price level and output. When AS shifts left, price levels rise, but output falls. This is known as cost-push inflation or stagflation. Any unexpected change in AS whether positive or negative is known as a supply shock.

Decreases in AS (stagflation) LRAS AS2 Price Level AS PL2 PL1 AD Q2 Q1 FE RGDP

Self-Correcting Nature of Economy In the long-run aggregate supply will shift so that equilibrium will be at the long-run level of output This happens as nominal wages and other input prices adjust to meet the current price level

Short run Equilibrium Below Full Employment -Lower price levels lead to lower wages, shifting SRAS right LRAS Price Level AS AS2 PL1 PL2 AD Q1 FE ,Q2 RGDP

Short run Equilibrium Above Full Employment -Higher price levels lead to higher wages, shifting SRAS left LRAS AS2 Price Level AS PL1 AD1 FE Q1 RGDP