Module 19- Equilibrium
By J.A. SACCO
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
Equilibrium
LRAS
SRAS
Price Level
140
At price level
140 AS>AD and
the price level
falls.
120
100
AD
0
1
2
3
4
5
6
7
Real GDP per Year
($ trillions)
8
9
10
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
Equilibrium
LRAS
SRAS
Price Level
140
At price level
100 AD>AS and
the price level
increases.
120
100
AD
0
1
2
3
4
5
6
7
Real GDP per Year
($ trillions)
8
9
10
6
Equilibrium
LRAS
SRAS
Price Level
140
At price level
120 AD=AS.
120
100
AD
0
1
2
3
4
5
6
7
Real GDP per Year
($ trillions)
8
9
10
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.
Consequences of Changes in Aggregate
Supply and Demand
8
• 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?
Consequences of Changes in Aggregate
Supply and Demand
• Contractionary Gap/Recessionary Gap
▫ Exist whenever the equilibrium level of real
national income is less than the full-employment
level
The Effects of Stable Aggregate Supply
and a Decrease in Aggregate Demand:
The Contractionary Gap
Price Level
LRAS
120
SRAS
E1
Contractionary
Gap
115
E2
AD1
AD2
0
7
6.5 6.8
Real GDP per Year
($ trillions)
Consequences of Changes in Aggregate
Supply and Demand
• Expansionary Gap/Inflationary Gap
▫ Exist whenever the equilibrium level of real
national income is greater than the fullemployment level
The Effects of Stable Aggregate Supply
and an Increase in Aggregate Demand:
The Expansionary Gap
Price Level
LRAS
SRAS
120
E1
AD1
0
7
Real GDP per Year
($ trillions)
The Effects of Stable Aggregate Supply
and a Increase in Aggregate Demand:
The Expansionary Gap
Price Level
LRAS
SRAS
120
E1
AD2
AD1
0
7
Real GDP per Year
($ trillions)
7.6
The Effects of Stable Aggregate Supply
and a Increase in Aggregate Demand:
The Expansionary Gap
LRAS
SRAS
E2
Price Level
125
120
E1
AD2
AD1
0
7
Real GDP per Year
($ trillions)
7.2
7.6
Expansionary
Gap
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
The Effects of Stable Aggregate Supply and an Increase in
Aggregate Demand: Demand-Pull Inflation
16
LRAS
SRAS
E2
Price Level
125
120
E1
AD2
AD1
Demand-Pull
Inflation
0
7
Real GDP per Year
($ trillions)
7.2
Intersection of AD2 and SRAS shows an increase in the price level.
17
Explaining Inflation:
Demand-Pull or Cost-Push?
• Cost-Push Inflation
▫ Inflation caused by a continually decreasing shortrun aggregate supply curve.
▫ Caused by an increase in costs of inputs which
decreases SRAS.
STAGFLATION!
The Effects of Stable Aggregate Demand and a Decrease in
Aggregate Supply: Supply-Side Inflation
18
LRAS
SRAS2
SRAS1
Price Level
E2
125
120
E1
Cost-Push
Inflation
0
6.8 7
Real GDP per Year
($ trillions)
AD1
19
The Oil Price
SRAS shifted
due
Shock of leftward
the
1970s
to the restrictions
Price Level
placed on the
supply of oil to
the U.S.
LRAS
SRAS2
SRAS1
E2
120
115
E1
AD1
0
2.8 3.0
Real GDP per Year
($ trillions)
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?