lecture 24 ECON 2030

ECON 2030 PRINCIPLES OF MACROECONOMICS

Instructor: Yushang Wei

The AD-AS Model

  • The Aggregate Demand-Aggregate Supply (AD-AS) model integrates the aggregate supply curve and the aggregate demand curve to analyze economic fluctuations.
  • Short-Run Macroeconomic Equilibrium:
    • Occurs when the quantity of aggregate output supplied equals the quantity of output demanded.
    • The equilibrium includes components:
    • inflation rate
    • quantity of aggregate output supplied
    • aggregate price level
    • Short-run Aggregate Supply (SRAS) curve intersects with aggregate demand.

Short-run Macroeconomic Equilibrium

Demand Shock

  • An event that shifts the aggregate demand curve.
  • Effects of Demand Shocks:
    • Demand shocks can be classified as either positive or negative.
    • Both types shift the Aggregate Demand (AD) curve, causing the aggregate price level and aggregate output to move in the same direction.
    • Equations:
    • GDP = C + I + G + NX
    • Where C = Consumption, I = Investment, G = Government Spending, NX = Net Exports.

Supply Shock

  • An event that shifts the supply curve known as Short-run Aggregate Supply (SRAS).
  • Effects of Supply Shocks:
    • Supply shocks can be classified as either positive or negative.
    • These shocks affect the inflation rate and aggregate output in opposite directions.

Long-run Macroeconomic Equilibrium

Definition and Characteristics

  • The economy achieves long-run macroeconomic equilibrium when the short-run equilibrium point aligns with the Long-run Aggregate Supply (LRAS) curve.
  • Components:
    • rGDP (real GDP) aligns with potential output (Yp).
    • Actual Output (actual GDP) is defined as the point where aggregate demand equals aggregate supply at the long-run level.

Gaps Explained

  • Recessionary Gap:
    • Occurs when aggregate output is below potential output.
    • Indicates underperformance of the economy.
  • Inflationary Gap:
    • Occurs when aggregate output is above potential output.
    • Reflects an overheated economy.

Output Gap

  • Definition:
    • The output gap measures the percentage difference between actual aggregate output and potential output.
    • Formula:
    • ext{Output Gap} = rac{ ext{Actual Aggregate Output} - ext{Potential Output}}{ ext{Potential Output}} imes 100
    • A positive output gap signifies an inflationary gap, whereas a negative output gap indicates a recessionary gap.

Long-run Dynamics

Self-Correction Mechanism
  • The economy demonstrates self-correcting features in the long run, where demand shocks only have short-run effects.
  • Negative Demand Shock:
    • Shifts the AD curve to the left, leading to a recessionary gap.
    • Effects include decreases in price level and aggregate output; unemployment rises.
    • Over time, nominal wages adjust downward, leading to a rightward shift in the SRAS curve and restoring equilibrium.
Positive Demand Shock
  • Initiated from an initial equilibrium that shifts AD to the right in the short run.
  • Results in an inflationary gap where both aggregate output and the inflation rate increase, and unemployment decreases.
  • In the long run, nominal wages adjust upward, causing the SRAS to shift leftward, ultimately restoring long-run equilibrium.