1.4 The Intereaction Of AD And AS

Question 1

What is short run equilibrium ?

Answer 1

• when the economy is in short run equilibrium, AD equals SRAS
• at output Y*, there is no upward or downward pressure on the price level, unless there is a shift in the AD or SRAS curve

Question 2

What is a positive and negative output gap ?

Answer 2

• When short run equilibrium is such that the level of real GDP is above the full employment level of output, we say there is a positive output gap (Y > Yf)
• if short run equilibrium real GDP is below the full employment level of output, we say there is a negative output gap (Y < Yf)

Question 3

What does a positive output gap look like ?

Answer 3

Question 4

What does a negative output gap look like ?

Answer 4

Question 5

Why does an inflationary gap only persists in the short run ?

Answer 5

• if there is an increase in AD, there is an extension along the SRAS curve, real GDP increases to Y1 which is greater than Yf, inflationary gap at B, with a higher equilibrium price level
• in the long run, inflationary pressure e.g workers demanding hifger wages, will lead to higher costs of production for firms decreasing SRAS, therefore the economy will return to full employment output at a higher price level

Question 6

Why does a deflationary gap only persist in the short run ?

Answer 6

Question 7

What is a business cycle ?

Answer 7

• An economic cycle or business cycle is the natural variation in economic activity (Real GDP) over time
• a full economic cycle includes natural upswing and downswing in actual output