1.4 Macroeconomic Equilibirum Flashcards
Macroeconomic Equilibrium (AD shift to the right)
Diagram
What happens to growth in macroeconomic equilibrium if there is an AD shift to the right?
Actual growth increases from Y1 to Y2. This is because with greater demand in the economy, firms respond by increasing output exhausting spare capacity; Y2 is now closer to the full employment level of output. This increase in output is an increase in real GDP, which is an increase in economic growth.
What happens to unemployment in macroeconomic equilibrium if there is an AD shift to the right?
Unemployment decreases. This is because labour is a derived demand, derived from the demand for goods and services. As the demand for goods and services is high, firms will need more workers to produce extra output, thus reducing unemployment.
What happens to inflation in macroeconomic equilibrium if there is an AD shift to the right?
Demand pull inflation increases from P1 to P2. This is because there is more pressure on existing factors of production increasing the price of them for firms. Firms will feed this through to higher prices of goods and services in the economy.
What happens to the trade position in macroeconomic equilibrium if there is an AD shift to the right?
The trade position in the economy is likely to worsen. This is because with a higher inflation rate, exports are less competitive, reducing the demand for them and the revenue brought in by them. Also, as economic growth increases, incomes increase leading to individuals sucking in imports, increasing the expenditure on imports.
Evaluation 1: How does the initial level of economic activity affect the impact of AD shift on macroeconomic equilibrium?
If the economy is initially operating with a large level of spare capacity (a large negative output gap), an increase in AD would most likely lead to a larger increase in output and decrease in unemployment. However, if the economy is close to fully utilising all available factors of production including labour and capital, it becomes extremely difficult for firms to find new workers to increase production or to increase their level of capital to produce more. As a result the level of output and employment will not increase as much but the enormous pressure on the limited factors of production will lead to a much greater rise in inflation and a large deterioration of the current account position.
Evaluation 2: How does the size of the multiplier affect the impact of AD shift on macroeconomic equilibrium?
The greater the size of the multiplier, the less that (interest rates need to fall, government spending needs to rise, taxation needs to fall, net exports need to increase etc) for there to be a large effect on output and employment. However, a larger multiplier will cause a greater problem of demand pull inflation as the economy will move closer to full employment levels pressurising existing factors of production. The smaller the multiplier, the more the initial increase in spending (AD) will have to be to have a large positive effect on growth and employment.
Macroeconomic Equilibrium (LRAS shift to the right)
What happens to growth in macroeconomic equilibrium if there is an LRAS shift to the right?
Potential and actual growth increases from FE1 to YFE2. This is because with greater demand in the economy, firms respond by increasing output. This increase in output is an increase in real GDP, which is an increase in economic growth.
What happens to unemployment in macroeconomic equilibrium if there is an LRAS shift to the right?
Unemployment decreases. This is because labour is a derived demand, derived from the demand for goods and services. As the demand for goods and services is high, firms will need more workers to produce extra output, thus reducing unemployment.
What happens to inflation in macroeconomic equilibrium if there is an LRAS shift to the right?
Cost push inflation decreases from P1 to P2. This is because there is less pressure on factors of production reducing the rate of their price increases thus reducing the rate at which the prices of goods and services rise.
What happens to the trade position in macroeconomic equilibrium if there is an LRAS shift to the right?
The trade position in the economy is likely to improve. This is because with a lower inflation rate, exports are more competitive, increasing the demand for them and the revenue brought in by them.
