ASAD - Short-Run Equilibrium and Changes in AS/AD (Lesson)
Short-Run Equilibrium and Changes in AS/AD
Introduction
Let's begin by looking at the point where aggregate supply equals aggregate demand—the equilibrium. We can find this point on the diagram below; it's where the aggregate supply, AS, and aggregate demand, AD, curves intersect, showing the equilibrium level of real GDP and the equilibrium price level in the economy.
At a relatively low price level for output, firms have little incentive to produce, although consumers would be willing to purchase a high quantity. As the price level for outputs rises, aggregate supply rises and aggregate demand falls until the equilibrium point is reached.
In this example, the equilibrium point occurs at point E, at a price level of 90 and an output level of 8,800.
How does the Economy Reach Equilibrium?
In macroeconomics, we seek to understand two types of equilibria, one corresponding to the short run and the other corresponding to the long run. The short run in macroeconomic analysis is a period in which wages and some other prices do not respond to changes in economic conditions. In certain markets, as economic conditions change, prices (including wages) may not adjust quickly enough to maintain equilibrium in these markets. A sticky price is a price that is slow to adjust to its equilibrium level, creating sustained periods of shortage or surplus. Wage and price stickiness prevent the economy from achieving its natural level of employment and its potential output. In contrast, the long run in macroeconomic analysis is a period in which wages and prices are flexible. In the long run, employment will move to its natural level and real GDP to potential.
Watch the video below to begin your study of the short run equilibrium.
Short-run Macroeconomic Equilibrium
Short-run macroeconomic equilibrium occurs when real GDP demanded equals real GDP supplied.
Use the color coded equation below to help in your understanding of equilibrium.
The Push and Pull of Inflation
Cost Push Inflation
- Cost-push inflation is caused by a shift in the AS curve
- It’s caused by an increase in the cost of an input with economy-wide importance
- For example, an increase in wages will cause an economy-wide increase in input costs
Demand Pull Inflation
- Demand-pull inflation is caused by a shift in the AD curve
- Demand-pull inflation occurs when the demand for goods and services increases at a time when the production of G/S is already high
- The increase in AD causes real GDP to expand and price level to increase
- “Too much money chasing too few goods”
Watch the presentation below to learn more about short run equilibrium and changes in AS/AD.
Just as demand and supply yield the price and quantity of a particular product, Aggregate Demand (AD) & Aggregate Supply (AS) determine the macroeconomic equilibrium - price level (telling whether we have inflation), quantity of goods and services (real GDP), and, indirectly unemployment.
Watch the video below to learn how these all work together.
Review
Review what you have learned by completing the activity below.
In Summary . . .
The aggregate demand/aggregate supply, or AD/AS, model is one of the fundamental tools in economics because it provides an overall framework for bringing economic factors together in one diagram.
We can examine long-run economic growth using the AD/AS model, but the factors that determine the speed of this long-term economic growth rate do not appear directly in the AD/AS diagram.
Cyclical unemployment is relatively large in the AD/AS framework when the equilibrium is substantially below potential GDP and relatively small when the equilibrium is near potential GDP.
The natural rate of unemployment—as determined by the labor market institutions of the economy—is built into potential GDP, but does not otherwise appear in an AD/AS diagram.
Pressures for inflation to rise or fall are shown in the AD/AS framework when the movement from one equilibrium to another causes the price level to rise or to fall.
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