Lecture Notes for ECON 2030: 25

ECON 2030: Principles of Macroeconomics Lecture Notes

Lecture Overview

  • Instructor: Yushang Wei
  • Lecture Number: 25

Long-run Macroeconomic Equilibrium

Negative Supply Shock
  • Starting Point: Always begin analysis at Long-run Equilibrium point (denoted as point___).
  • Cause: The negative supply shock is attributed to increased production costs due to higher oil prices.
  • SRAS Shift: The Short-Run Aggregate Supply (SRAS) curve shifts to the left (denoted as ___ ).
  • New Equilibrium: The economy ends up at point (denoted as point ___ ).
  • Economic Indicators:
    • Real GDP (rGDP) movement: __
    • Price level (inflation rate): __
    • Unemployment rate: __
  • Output Gap: There is a ___ output gap.
  • Phenomenon: This situation leads to . It is referred to as stagflation, which is defined as the ___ (simultaneous occurrence of high inflation and unemployment).
  • Future Adjustment: Eventually, as input prices decrease, the SRAS will shift to the right (denoted as ) and the economy will stabilize back to the Long-run Aggregate Supply (LRAS) level.
  • Illustration of Effects:
    • Price Level Inflation: LRAS shifts left from B to A indicating a recessionary higher inflation condition.
    • Aggregate Demand (AD): The relationship between rGDP and potential GDP (denoted as Yp) can be represented as (B - A) * GDP aggregate output.
Positive Supply Shock
  • Starting Point: Begin analysis at Long-run Equilibrium point (denoted as point___).
  • Cause: The positive supply shock occurs due to lower production costs brought about by decreases in oil prices.
  • SRAS Shift: The SRAS curve shifts to the right (denoted as ___ ).
  • New Equilibrium: The economy reaches a new equilibrium at point (denoted as point ___ ).
  • Economic Indicators:
    • Real GDP (rGDP) movement: __
    • Price level (inflation rate): __
    • Unemployment rate: __
  • Output Gap: There is a ___ output gap.
  • Future Adjustment: Eventually, if input prices increase again, the SRAS will shift to the left (denoted as ) and may set back to the original point A.
  • Illustration of Effects: Price levels may increase (denoted as pl/inflation) and the relationship of AD must return to maintain stability in rGDP.

Summary of Macroeconomic Dynamics

  • Short-run Variability: In the short-run, rGDP, unemployment, and inflation levels can deviate due to changes in either aggregate demand (AD) or short-run aggregate supply (SRAS).
  • Demand Shocks: If the economy experiences a demand shock, it will (eventually) return to its Long-run equilibrium level. However, if the shock is substantial, it may necessitate intervention. The use of macro-policy can shift AD back to promote recovery.
  • Policy Rationale: This supports active stabilization policy, defined as the use of government interventions to lessen the impact of recessions and to mitigate overly strong economic expansions.

Policy in the Face of Demand Shocks

  • Response to Declines in AD: Policymakers can leverage either monetary or fiscal policy to shift the aggregate demand curve back to the right. Immediate action can prevent a recession from deepening.
  • Benefits of Action:
    • Maintains economic output: Prevents the decline in aggregate output which is often linked to rising unemployment.
    • Deflation Prevention: Ensuring price stability is critical for economic health.

Considerations Against Continuous Policy Intervention

  • Caution in Policy Implementation: Should policymakers always act to counter declining aggregate demand? Not necessarily.
    • Potential Consequences: Certain stabilization measures may incur long-term costs such as:
    • Increased budget deficits, affecting long-run growth.
    • Uncertainty: Policymakers often lack complete information about economic conditions, which might lead to unpredictable outcomes from their interventions.
  • Risk of Policy Missteps: There’s a potential downside where stabilization policies could result in more harm than benefit.

Clicker Questions and Key Concepts

  • Upward Slope of SRAS: The short-run aggregate supply curve slopes upward because higher inflation rates lead to increased outputs, given that most production costs remain fixed in the short run.
  • Commodity Price Changes: Changes in commodity prices can trigger shifts in the short-run aggregate supply curve.
  • Wage Changes and SRAS: A decrease in nominal wages results in a rightward shift of the short-run aggregate supply curve.
  • Definition of Potential Output: Potential output refers to the level of real GDP that the economy would produce if all prices, including nominal wages, were fully flexible.
  • Inflation Rate Impact: A decrease in the inflation rate would NOT increase potential output.