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 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