10.3 Equilibrium
 We will now consider AD and AS together
 An economy’s equilibrium price level and real output occur at
the intersection of the AD and AS curves
Inventory Changes
Inventory Increase & Decrease
 Imagine price level is above equilibrium price level, at “a”
 At “a”, real output exceeds real expenditures, i.e. more is produced
than purchased
 Businesses have a surplus
 “Positive Unplanned Investment”
 An unintended rise in
inventories causes businesses
to lower prices until output
and expenditures are at the
same point, “B”
 When price level is below eq.
value “c”, there is an
unintended fall in inventories, so
businesses increase prices until
equilibrium is reached, “b”
a
a
b
c
c
Inventory Changes
The Role of Unplanned Investment
 Whether there is an unintended increase or decrease in
inventory, unplanned investment plays a big role in stabilizing
the economy
 Unplanned Investment is the difference between AD and AS
 The $20 trillion discrepancy between AD and AS at a price level
of 100 means there is an unintended $20 trillion increase in
inventories
Injections & Withdrawals
Movement toward equilibrium can also be seen by looking at
flows of income payments and purchases that connect resource
and product markets
 3 Flows/Injections that add to the main income-spending
stream in any economy:
 Investment (I)
 Government Purchases (G)
 Exports (X)
 3 outward flows/Withdrawals
 Savings (S)
 Taxes (T)
 Imports (M)
Investment and Saving
The amount saved and invested in an economy are different
 Companies keep a portion of profits to reinvest
 Governments also borrow money
 International flows (borrowing from
foreign countries)
Government Purchases & Taxes
 Transfer payments/business subsidies = “Negative Taxes”
 At some points in time, government purchases exceed taxes,
so they borrow money in financial markets
 At other times, taxes exceed government purchases, so
governments use excess revenues to pay off some outstanding
debt
Exports & Imports
 Typically, Canada imports more than it exports
 i.e. we spend more on products from the rest of the world that
receive revenues from selling products to rest of the world
Total Injections & Withdrawals
 While individual injections and withdrawals aren’t necessarily
equal, they all balance each other overall, otherwise Canada’s
economy wouldn’t be working as it is
 Total Injections = I + G + X
 Total Withdrawals = S + T + M
 If TI > TW, we have an expanding economy
 If TI < TW, we have a declining economy
 If TI = TW, we have equilibrium
Equilibrium vs Potential Output
 Recessionary Gaps
An economy’s real output rarely equals its potential output
If equilibrium output is below potential level, unemployment is
above the natural unemployment rate
Difference between equilibrium output and potential
output is known as a recessionary gap
Vertical, purple line is potential output
Equilibrium vs Potential Output
 Inflationary Gaps
If equilibrium output is above potential level, unemployment is
below the natural unemployment rate
Inflation will accelerate if this situation persists
Difference between equilibrium output and potential
output is known as an inflationary gap
Vertical, purple line is potential output
*Note* a recession differs from a recessionary
gap. Coming up: during a recession, real
output moves from above to below its
potential level