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EQUILIBRIUM POSITION OF NATIONAL OUTPUT
where AD and AS curves intersect
if either AS or AD shift, then equilibrium position will change
size of change will depend on size of shift and elasticity of the curve which hasn’t moved
SHORT TERM- SRAS SHIFT
initial equilibrium level is P1Y1, where AD1 and SRAS1 intersect
but increase in SRAS1 to SRAS2 has changed the equilibrium position to P2Y2
led to fall in the price level and increase in real GDP
decrease in SRAS would lead to higher prices and lower real GDP
SHORT TERM- AD SHIFT
initial equilibrium level is P1Y1 where AD1=SRAS1
increase in AD curve to AD2 led to change in equilibrium to P2Y2
prices and real GDP are higher
fall in AD would lead to lower prices and lower real GDP
LONG TERM- CLASSICAL
as classical LRAS curve is perfectly inelastic, a shift of AD curve wouldn’t affect long run national output and would only affect price levels
classical economists believe that economy will always return to full employment level and so there won’t unemployment in long run
CLASSICAL LRAS- DIAGRAM
believe that increase in AD from AD1 to AD2 will lead to pos output gap
economy is in long term disequilibrium as SRAS1 and AD2 don’t intersect on LRAS curve
short-term equilibrium is P2Y2- means that there’s over-full employment and firms will end up bidding up wages of labour and other factor prices
so SRAS shifts to SRAS2 as cost of production has increased
economy is producing the same amount but now at higher prices: they are producing at Y1P3
short run equilibrium has shifted and is now the same as the long run equilibrium
CLASSICAL LRAS- LRAS SHIFT
only way to increase output is by increasing LRAS- changes in AD w/out change in LRAS are only inflationary
initial equilibrium is where AD1=LRAS1 at P1Y1
increase in LRAS from LRAS1 to LRAS2 caused lower prices and higher output, at P2Y2
although there’s short term disequilibrium, as SRAS1 doesn’t intersect the curve at this point, they believe this will be closed by a shift in SRAS
rise in LRAS likely to lead to lower prices and higher output
when compared to rise in AD which causes increase prices and no higher output, its clear to see why classical economists favour supply-side policies over demand management
LONG TERM- KEYNESIAN
agree with classicists that there is full employment where LRAS is vertical
but believe there can be equilibrium at less than full employment- where curve is horizontal
bc they don't believe that rise in unemployment rapidly leads to a fall in real wages
KEYNESIAN- DIAGRAM
would agree with classicists that shift from AD3 to AD4 is purely inflationary
but believe if economy is in a recession then an increase from AD1 to AD2 is opposite and only increases output not price
KEYNESIAN- LRAS SHIFT
impact of shift in AD strongly depends on elasticity of the curve, and whether economy is at or near full employment
If economy is producing at or near full employment, (e.g. AD1) then rise in LRAS will increase output and decrease price level
but if economy is in recession (e.g. AD2) then increase in LRAS will have no effect on prices or output
why Keynesians argue that during recessions gov has to increase AD rather than using supply side policies
INCREASING AD AND AS
in macro, factor which affects AD can affect AS
e.g. investment- component of AD so an increase in it will increase AD but could also increase LRAS as firms can produce more if they have more machines etc.
may mean that the long run disequilibrium caused by shift in AD will be brought back to equilibrium by an increase LRAS rather than a fall in AD
but not all investment results in increased production (e.g. firm may invest but then go out of business) and so LRAS won’t increase
so extent to which investment increases output and lessens inflation depends on its rate of return
