1. Equilibrium in the Aggregate Demand-Aggregate Supply Model
Module 19
April 2015

2. The AD-AS Model
In the AD-AS Model, the aggregate supply curve and the aggregate demand curve are used together to analyze economic fluctuations

3. SR Macroeconomic Equilibrium
The economy is in short-run macroeconomic equilibrium when the quantity of aggregate output supplied is equal to the quantity demanded
Short-run equilibrium aggregate price level is the aggregate price level in the short-run macroeconomic equilibrium
Short-run equilibrium aggregate output is the quantity of aggregate output produced in the short-run macroeconomic equilibrium

4. AD-AD Model

5. Shifts of Aggregate Demand: Short-Run Effects
Demand shock – events that shift the aggregate demand curve (Great Depression was a negative demand shock fixed by WWII government spending which was a positive demand shock).

6. Demand Shocks

7. Shifts of the SRAS Curve
Supply shock – an event that shifts the short- run aggregate supply curve
Negative supply shock raises production costs and reduces quantity produced – oil crises of 1973 and 1979
Positive supply shock reduces production costs and increase quantity supplied – Internet and new technology between

8. Shifts of SRAS Curve
Stagflation – the combination of inflation and stagnating (or falling) aggregate output
Leads to rising unemployment
Supply shocks - cause the aggregate price level and aggregate output to move in the opposite directions

9. Supply shocks

10. Long-Run Macroeconomic Equilibrium
The economy is in long-run macroeconomic equilibrium when the point of short-run macroeconomic equilibrium is on the long- run aggregate supply curve

11. Long-Run Macroeconomic Equilibrium

12. Long-Run Macroeconomic Equilibrium
Recessionary gap – when aggregate output is below potential output
Corresponds to high unemployment
Early 1930s Germany
Causes the SRAS to shift gradually to the right

13. Short-Run vs Long-Run Effects of a negative demand shock

14. Long-Run Macroeconomic Equilibrium
Inflationary gap – when aggregate output is above potential output
Output gap – the percentage difference between actual aggregate output and potential output.
The economy is self-correcting when shocks to aggregate demand affect aggregate output in the short run, but not the long run
𝑂𝑢𝑡𝑝𝑢𝑡 𝑔𝑎𝑝= 𝐴𝑐𝑡𝑢𝑎𝑙 𝑎𝑔𝑔𝑟𝑒𝑔𝑎𝑡𝑒 𝑜𝑢𝑡𝑝𝑢𝑡−𝑝𝑜𝑡𝑒𝑛𝑡𝑖𝑎𝑙 𝑜𝑢𝑡𝑝𝑢𝑡 𝑝𝑜𝑡𝑒𝑛𝑡𝑖𝑎𝑙 𝑜𝑢𝑡𝑝𝑢𝑡 x 100

15. Short-Run vs. Long-Run Effects of a positive demand shock

16. Check Your Understanding
1. Describe the short-run effects of each of the following shocks on the aggregate price level and on aggregate output.
A. the government sharply increases the minimum wage, raising the wages of many workers.
B. solar energy firms launch a major program of investment spending
C. congress raises taxes and cuts spending.
D. severe weather destroys crops around the world

17. Check your understanding
2. A rise in productivity increases potential output, but some worry that demand for the additional output will be insufficient even in the long run. How would you respond?

18. MC ??? 1. Which of the following causes a negative supply shock?
I. a technological advance
II. Increasing productivity
III. An increase in oil prices
I only
II only
III only
I and III only
I, II, and III

19. MC ??? 2. Which of the following causes a positive demand shock?
a. an increase in wealth
b. pessimistic consumer expectations
c. a decrease in government spending
D. an increase in taxes
E. an increase in the existing stock of capital

20. MC ???
During stagflation, what happens to the aggregate price level and real GDP?
Aggregate Price Level Real GDP
A. decreases increases
B. decreases decreases
C. increases increases
D. increases decreases
E. stays the same stays the same

21. MC ??? Refer to the graph for questions 4 and 5
4. Which of the following statements is true if this economy is operating 𝑃 1 𝑎𝑛𝑑 𝑌 1 ?
I. the level of aggregate output equals potential output
II. It is in short-run macroeconomic equilibrium
III. It is in long-run macro equilibrium
A. I only
B. II only
C. III only
D. II and III
E. I and III

22. MC ??? 5. The economy depicted in the graph is experiencing a(n)
A. contractionary gap
B. recessionary gap
C. inflationary gap
D. demand gap
E. supply gap

23. Free Response 1. Refer to the other graph
A. is the economy in short-run macroeconomic equilibrium? explain.
B. is the economy in long-run macroeconomic equilibrium? Explain.
C. what type of gap exists in this economy?
D. calculate the size of the output gap.
E. what will happen to the size of the output gap in the long run?