Module 5: Long-Run Aggregate Supply & Aggregate Demand

Long-Run Aggregate Supply Curve (LRAS)

LRAS represents the total quantity of goods and services that an economy can produce when resources are fully employed.

• It reflects sustainable production levels, assuming:

  • All prices adjust

  • Labor, physical capital, and other resources are efficiently used

(T/F): The price level has a significant affect on LRAS

FALSE - the price level has NO AFFECT on LRAS

Is Price Level a GDP Deflator? (Explain Why or Why Not)

Yes - Price Level is the broadest GDP Deflator as it covers how all prices in an economy move

What is the X axis of the LRAS Supply Curve?

Real GDP

What is the Y axis of the LRAS Supply Curve?

Price Level

What direction does the LRAS Run? And Why?

Vertically - this shows that in the long run, output depends on resources and technology - not prices

What does it mean when Markets are in equilibrium?

All markets in the economy - labor, goods, and capital are balanced. This means no one has an incentive to change prices or output.

• Unemployment is at a natural rate (Full employment)

What does the LRAS represent?

Potential Real GDP, NOT MAXIMUM

How is long run growth shown by the LRAs

By an outward shift of the LRAS

• increase shifts it to the right

• decreases shifts it to the left

What causes the LRAS to shift?

POLE

• +/- Labor (L)

• +/- Other resources, past actions, and capital (O)

• +/- Technology (P)

• +/- Productivity (P)

• +/- Human Capital and Education (E)

What is the Aggregate Demand Curve?

It shows planned purchase rates for all goods and services at various price levels with all other things held constant

Aggregate Demand Curve Equation

Consumption + Investment + Government Spending + Net Exports (Exports - Imports)

What is the shape of the Aggregate Demand Curve

It is downward sloping, because as price level rises, real GDP demand declines

What direction does the AD shift if a non-price level change increases aggregate domesting spending?

Right

What direction does the AD shift if a non-price level change decreases aggregate domestic spending

Left

What direction does AD shift if prices change?

It does not shift - it just moves along the AD line

What factors increase Aggregate Demand right?

• Improvements in Economic conditions abroad → More exports

• Decreased Value of Currency → More exports (things become cheaper for other countries so they buy more)

• Increased Job Security and/or increased future income

• Reduction in Real Interest Rates → higher consumption

• Tax decreases → Higher consumption and investment

• Increase in Money Circulated → impacts everything

How did you figure out the Equilibrium Price level>

It is where the LRAS and AD intersect

• real expenditures for the economy are equal to potential production (GDP)

What is Secular Deflation and what causes it?

An increase in LRAS - this will result in a decrease in the price level in the long run

Explain what happens to GDP and Price level when the lRAS shifts right

DEFLATION

• GDP: increases

• Price Level: decreases

What happens to an economy that experiences a leftward shift in LRAS?

INFLATION

• Price level: INCREASES

• GDP: DECREASES

When LRAS shifts [RIGHT/LEFT], inflation occurs

Left

When LRAS shifts [RIGHT/LEFT], deflation occurs

Right

Explain what happens to Price Index and GDP when AD shifts right

• Price Index: Increases

• GDP: Remains the same

When AD shifts [RIGHT/LEFT], inflation occurs

Right

When AD shifts [RIGHT/LEFT], deflation occurs

Left

Explain what happens to Price Index and GDP when AD shifts left

• Price Level: Decreases

• GDP: Remains the same

When both the LRAS and AD shift, where do you find the new equilibrium?

Where the NEW LRAS and AD intersect

(T/F): When the LRAS and AD shifts, changes in potential GDP are always clear

TRUE

When both LRAS and AD shift, when is it CLEAR to see the long run prices?

When the AD and LRAS move DIFFERENT DIRECTIONS

• AD Right, LRAS left

• AD Left, LRAS right

When both LRAS and AD shift, when is it INDETERMINATE to see the long run prices?

When AD and LRAS move the same direction

• AD Right, LRAS Right

• AD Left, LRAS Left