Transcript Aggregate Demand and Aggregate Supply

Aggregate Demand and Aggregate
Supply in the Long Run
Aggregate Supply in the Long Run
P
ASlr
In the long run, all of the economy’s
resources are fully employed.
P2
As a result, the aggregate supply
curve is vertical, demonstrating that
output (Y) is constant at every
price level.
P1
Note that Y equals Yfemp at P2 and P1.
0
Yfemp
Y
Aggregate Demand and Aggregate
Supply in the Long Run
P
ASlr
In the long run, all of the economy’s
resources are fully employed.
P2
Consequently, if aggregate demand
increases or decreases in the long run,
it results only in a change in the
price level.
AD2
P1
AD1
0
Yfemp
Y
Note that an increase in aggregate
demand from AD1 to AD2 causes the
price level to rise to from P1 to P2, while
a decrease in aggregate demand from
AD2 to AD2 causes the price level to fall
from P2 to P1
Aggregate Demand and Supply:
Short Run
AS
P
In the short run, the aggregate supply curve is
flat or upward sloping.
The flat section occurs when the unemployment
of resources is high.
The upward sloping section occurs when there are
lower levels of resource unemployment.
0
Y
Aggregate Demand and Supply:
Short Run
AS
P
Given an upward sloping short-run aggregate
supply curve, changes in aggregate demand
change both the price level, P, and output, Y.
Increases in AD cause Y and P to rise.
Decreases in AD cause Y and P to fall.
AD3
AD2
0
Y1 Y2 Y3
AD1
Y
Aggregate Demand and Supply:
Short Run
AS1
P
AS2
AS3
In the short run, changes in AS change P and Y.
Increases in AS cause Y to rise and P to fall.
Decreases in AS cause Y to fall and P to rise.
AD1
0
Y1 Y2 Y3
Y
Aggregate Demand and Supply
P
ASlr
ASsr
Long run equilibrium occurs at the
intersection of aggregate demand and the
long run aggregate supply curve where
P = P and Y = Y.
Since in the long run all prices have
adjusted, short run equilibrium occurs
at the same P-Y combination.
P
AD
0
Y
Y
Reduction in Aggregate Demand
ASlr
P
A decrease in aggregate demand from
AD1 to AD2 moves the economy from
point 1 to point 2.
AS1
AS2
2
P1
1
ASlr > AD, causing the price level to fall.
3
P2
0
At point 2 the economy is in a recessionary
gap equal to Y* - Y1 because the economy
is below Y*, the full employment level of Y.
AD2
Y1
Y*
AD1 Decreases in P increase aggregate demand,
causing Y to rise from Y1 to Y*.
Y
Decreases in wages cause the aggregate
supply curve to shift right.
Increase in Aggregate Demand
P
P2
P1
An increase in aggregate demand from
AD1 to AD2 moves the economy from
point 1 to point 2.
ASlr AS
2 AS1
At point 2, the economy is in an
inflationary gap equal to Y1 – Y*
because Y1 is above Y*, the full
employment level of Y.
3
1
2
AD > ASlr, causing the price level to
AD2 rise.
AD1
0
Y* Y1
Y
Increases in P decrease aggregate
demand, causing Y to fall from Y1 to Y*.
Increases in wages cause the aggregate
supply curve to shift left.
Adverse Aggregate Supply Shock
ASlr
P
P2
P1
AS2
AS1
Adverse supply shocks push up costs and
prices. If aggregate demand is fixed,
the economy moves from point 1 to
point 2 as Y falls and P rises.
2
1
At point 2, AD < AS and Y1 < Y*. Output
is lower and the price level is higher. This
is known as “stagflation.”
AD
0
Y1 Y*
Y
To reach Y*, prices and wages must fall..
Increase in Aggregate Supply
P
P1
P2
ASlr
AS2
AS1
Increases in aggregate supply push down
costs and prices. If aggregate demand is
fixed, the economy moves from point 1 to
point 2 as Y rises and P falls.
1
2
AD
0
Y1 Y*
Y
In the USA during the 1990s,
increases in productivity, decreases in
resource costs, and a strong dollar that
decreased the cost of imports resulted in
a rightward shift of the aggregate supply
curve
Conclusions: Long Run
• The crucial difference between the long and
short run is that output is inflexible in the
long run but not the short run.
• The long run aggregate supply curve is
vertical. Therefore, shifts in aggregate
demand cannot change output in the long
run.
Conclusions: Short Run
• The short run aggregate supply curve is
upward sloping.
• Therefore, shifts in aggregate demand can
change levels of output and price levels.
• Shocks to aggregate demand and short run
aggregate supply can cause fluctuations in
economic activity.
Conclusions: Short Run
• Since the government can shift aggregate
demand with fiscal and monetary policy, as
well as aggregate supply with fiscal policy
stabilization policies can be used to offset the
impact of shifts in aggregate demand and
aggregate supply.