Short & Long-run Equilibrium §

Short-run equilibrium: §

The Aggregate Demand (AD) curve intersects the Short-run Aggregate Supply (SRAS) curve, short-run equilibrium occurs. This is the actual level of spending, production, and income.

Long-run Equilibrium §

All 3 curves (AD, LRAS, and SRAS) all intersect one another. This implies actual output equals maximum potential output. 500

#econs-example The Economy does not always operate at long-run equilibrium

In June 2020, economic growth was negative as a result of economic disruption from COVID; Actual GDP was estimated ~2,000 Billion This occurred as a result of the unemployment rate of ~7%, higher than the natural rate of ~5% at that time. In this scenario, AD and SRAS intersected to the left of the LRAS curve.

Overtime all curves, SRAS, LRAS, and AD Curves, shift to the right as a result of economic growth. LRAS & SRAS grow due to;

• Population growth because of sex, and migration. 🠱Availability of resources > 🠱SRAS Also; 🠱 Population > 🠱 Households buying goods & 🠱 Potential Size of Workforce > 🠱 LRAS
• Capital Stock (machinary / housing, factories, social infrastructure etc.) grow as new projects & businesses develop. ⬇ Costs of Production > 🠱SRAS 🠱 Productivity influenced by Capital > 🠱LRAS

AD Curve also increases as a result of the increased consumption and investment (AD Factors).

Tip

The AD & AS curves may not shift at the same rate, the short-run equilibrium may be below, or above, it’s potential. The Difference is the contractionary gap, and expansionary gap.

Contractionary and Expansionary Gaps §

Contractionary Gap §

AS Contractionary Gap.excalidraw

short run equilibrium is below the Real GDP that the LRAS determines as he Potential Level. This means there is a contractionary gap, this is similar to a Contraction phase in the business cycle. Characteristics include;

• Lower Rates of Inflation (spare capacity in economy)
• High rates of Cyclical Unemployment << Check dat#review
• A fall in the labour force participation rate (if unemployed workers feel they cant find a job)
• Lower company profits
• Slower growth of consumer expenditure (particularly on durables)
• Increased need for social security (e.g. Job Seeker allowance)
• Lower Interest Rates
• A Fall in the Current Account Balance, will cause increased investment relative to savings.

What prevents the infinite downturn cycle §

What breaks / prevents the infinite downturn cycle

When actual GDP is below potential GDP, (contractionary gap present); Unemployment is above natural rate > ⬇Real Wages > ⬇Short-term Costs of Production > 🠱SRAS

Increased SRAS means a shift to the right, pushing the economy towards potential GDP. at the same time, as we approach potential GDP, demand may rise due to;

• 🠱Consumer/Business Confidence
• Government / RBA implementation of expansionary policies that encourage private sector spending

Expansionary Gap §

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Short run equilibrium is at a level of Real GDP that is higher, thus, to the right of the potential GDP indicated by the LRAS curve, this is an expansionary gap. seen on the model above as Real GDP () being greater than Potential GDP ().

The characteristics of a Expansionary Gap are similar to the Expansionary phase of the business cycle, for example;

• Wage inflation if there is a tight labour market
• An Increase in the participation rate (people expect to be able to find work)
• Lower levels of cyclical unemployment (Consumer demand high, firms employ more labour resources)
• An increase in company porifts & business confidence
• 🠱 Consumer / Business Confidence
• 🠱 Sales of consumer durables / luxury items
• Reduced need for cyclical welfare payments, such as unempl0oyment benefits (Job Seeker)
• The Current Account Balance will fall if Investment increases relative to savings.

What prevents infinite expansionary gap §

What prevents infinite expansion

As outlined in Peak Stage of the business cycle, eventually expansion begins to plataeu. we would also expect an increase in Fiscal / Monetary policy to reduce spending in the economy which will decrease some components of AD, and thus, shift the aggregate demand curve to the left. (probably see Chapter 12, or Chapter 13)