Equilibrium in the Aggregate Demand-Aggregate Supply Model - Section 4, Module 19

AD-AS Model - The basic model we use to understand economic fluctuations, such as changes in real GDP, employment, and the aggregate price level

intersection point of AD-AS has equilibrium price level and output

Surplus (aggregate price level is above equilibrium) = fall in aggregate price level until AD=AS

• opposite for shortage

demand shock - an event that shifts the AD curve

supply shock - an event that shifts the AS curve

• stagflation - the combination of inflation and falling aggregate output (stagnation + inflation) → caused by negative supply shift

  • falling output leads to rising unemployment + decreased purchasing power bc of inflation

• unlike demand shocks, supply shocks cause price and output to move in opposite directions

fiscal and monetary policy can easily cause demand shocks, but it is harder for the govt to create supply shocks

long run macroeconomic equilibrium - when short run equilibrium is at the same place as the LRAS

recessionary gap - when short run equilibrium is below potential output

inflationary gap - when short run equilibrium is above potential output

• both shift back to LRAS eventually

output gap - the difference between actual aggregate output and potential aggregate output → tends to be towards zero in the long run