Macroeconomic Equilibrium

Question 1

SR and LR Equilibrium

Answer 1

SRAS meets AD -> level produced is = amount demanded -> no reason to produce more

AD = AS but two types of AS (Neoclassical and Keynesian)

Question 2

Neoclassical AS

Answer 2

economy will always move towards its LR equilibrium at full employment level of output -> only impact on AD will be prices

will move here without govt intervention

only possible to have increased output/supply in SR -> not sustainable for labor or resources -> increases production costs -> increase in price level

Question 2

SR and LR Equilibrium

Answer 2

SRAS meets AD -> level produced is = amount demanded -> no reason to produce more

AD = AS but two types of AS (Neoclassical and Keynesian)

Question 3

Inflationary gap

Answer 3

An inflationary gap is the difference in what gross domestic product (GDP) would be under full employment and the actual reported GDP number.

Inflationary gaps occur when increased demand for labor leads to higher wages, which in turn lead to increased demand for goods and services.

The increase in demand leads to new revenue and higher materials prices—if they can meet the increase in demand profitably.

If they can’t, then the gap represents lost welfare.

Question 4

Deflationary gap

Answer 4

where the level of national income is lower than the equilibrium point at which resources are fully employed.

AD falls due to:

Fall in exports (global recession)
Fall in investment (due to banking collapse and credit crunch)
Fall in consumer spending (e.g. higher interest rates, falling wages.)
Economic growth below the average trend rate of growth (AD increasing at slower rate than productive capacity)

Question 5

Keynesian perspective

Answer 5

equilibrium level of income can occur at different levels = economy can be at EQ even at levels that do not fully employ resources

EQ depends more on AD rather than movement in LRAS

there can be an increase in demand that does not cause price increase because they have unused resources

as economy moves from phase 2-3 increase in D increases prices (inflationary pressure) from resources becoming less available

increases to AD at phase 3 would have purely inflationary effect and increase prices without change in output