1. Macroeconomic Equilibrium and Changes
Define what is meant by equilibrium in the macro economy
Explain how equilibrium is determined
Explain how equilibrium might change

2. Macroeconomic equilibrium
Where AD = AS

3. Macroeconomic equilibrium
What if AS was greater than AD? Eg Ys and Yd
Price level AS
Producers would have excess stock, reduce their output levels and output would contract back to equilibrium P AD
Prices may fall unless the economy was on the elastic part of the AD curve Y
Real GDP

4. Macroeconomic equilibrium
What if AD was greater than AS? Eg Ys and Yd
Price level AS
Producers would be short of stock, start to produce more and output would expand back to equilibrium P
Prices may rise unless the economy was on the elastic part of the AD curve AD Y
Real GDP

5. Circular flow of income
Recap – draw the circular flow of income on your whiteboards What can we say about the circular flow and macroeconomic equilibrium? What was the multiplier effect? We can therefore draw the multiplier effect using the AD and AS diagrams

6. Multiplier effect The initial increase in AD moves AD to AD1
This increases output to £25bn
This demand becomes income in hands of others (suppliers, employees)
Price level
These people then spend on goods and services which increases AD to AD2
This increases output to £30bn
How far AD moves to the right will be determined by how high the multiplier is
Real GDP £bn

7. Changes in Aggregate Demand
The effect of a change in AD on the level of unemployment, inflation and output, will depend on 3 things:
Where the economic level currently is
What the size of the multiplier is
The size of the change in AD
Let’s look at some examples….

8. Changes in Aggregate Demand
The economy is at a level which is below full capacity - AD and Y
Price level
An increase in AD to AD1 will increase output Y1 and increase employment but the price level - P (inflation) will not increase
Real GDP

9. Changes in Aggregate Demand
The economy is at a level which is below full capacity - AD and Y
Price level
The increase in AD to AD1 takes the economy into a situation where shortages are starting
This means that output increases to Y1, employment will fall but now there could be wage rises which causes the price level to increase to P1
Real GDP

10. Changes in Aggregate Demand
Price level
The economy is at a level which is at full capacity- AD and Y – prices are rising
The increase in AD to AD1 does not result in more output because the economy is at full employment
This means that there are wage rises which causes price level to increase to P1
Real GDP

11. Changes in Aggregate Supply
The effect of a change in AS will also depend on
The size of the change
Where the economy starts from
Let’s look at some examples….

12. Changes in Aggregate Supply
The economy is at a level which is below full capacity - AS and Y
Price level
An increase in AS to AS1 will raise potential output but will not raise actual output because demand is too low. Price remains the same at P
Real GDP

13. Changes in Aggregate Supply
The economy is at a level which is just below full capacity- AS which gives output Y and price P
Price level
An increase in AS to AS1 will raise actual output and also lower the price level to P1
Real GDP

14. Changes in AD and AS
In most economies AD and AS will both grow over time as consumption, investment and technology increase
If this is gradual then the economy should stay in equilibrium

15. Changes in AD and AS AD increases to AD1 as consumption increases
Price level AS
AS1
AS increases to AS1 as technology improves
If they are matched then the price level should not increase P
AD1 AD Y Y1
Real GDP

16. Changes in AD and AS - overheating
AD increases to AD1 which is more rapidly than AS in increasing. Output increases but….
Price level
This creates pressure on the price level as resources are scarce – inflation increases
The economy is overheating – this is not sustainable unless AS increases to match AD
Real GDP

17. Output Gap - Negative
A negative output gap is where the economy is producing at a level below full capacity – there are unemployed resources
Where did we see this concept before?
PPC curve – how did we show the situation where there was underused resources?

18. Negative output gap on PPC curve
Capital goods
Consumer goods

19. Negative output gap Full employment is at output level Yfe
Price level
Full employment is at output level Yfe
The economy is at output Y which is below this point
The difference is a negative output gap
Real GDP

20. Output Gap - Positive
A positive output gap is where the economy is producing at a level above full capacity – there are overemployed resources This could be where people are working additional overtime or a machine is used more than it should be It is not a sustainable situation PPC curve – where would this point be on a PPC curve?

21. Positive output gap on PPC curve
Capital goods
Consumer goods

22. Positive output gap
AS could temporarily increase to ASt by a surge in AD to AD1
Price level
This could increase output and cause inflation (Y1 and P1)
Eventually AS would fall back to AS as resources stopped being used
Real GDP