1.4 - Short run macroeconomic
equilibrium
When the economy is in short run equilibrium, aggregate demand equals aggregate supply. This
means that the value of total output produced in the economy is exactly equal to the total spending
on goods and services.
At output Y*, there is no upward or downward pressure on the price level to change from PL*. The
economy will remain at this point unless something causes AD or SRAS to shift.
We can also say how the economy will be affected in the long run by looking at the position of the
LRAS relative to the short run equilibrium. If it is ahead of the equilibrium, then we can predict that
factors of production will increase in the long run.
When writing questions, always write which component is affecting AD, then refer to the graph.
Output Gaps
In order to understand what happens to the economy over a period of time, we need to
know where the short run equilibrium is relative to the full employment level of output.
Inflationary Gaps
If the short run equilibrium is such that the level of real GDP is above full employment level
output, we say that there is an inflationary gap (Y>Yf). This occurs when the productivity of
factors of production increases and they are overworked. However, this demands an
increase in factor incomes and therefore pushes prices up along with nominal GDP.
equilibrium
When the economy is in short run equilibrium, aggregate demand equals aggregate supply. This
means that the value of total output produced in the economy is exactly equal to the total spending
on goods and services.
At output Y*, there is no upward or downward pressure on the price level to change from PL*. The
economy will remain at this point unless something causes AD or SRAS to shift.
We can also say how the economy will be affected in the long run by looking at the position of the
LRAS relative to the short run equilibrium. If it is ahead of the equilibrium, then we can predict that
factors of production will increase in the long run.
When writing questions, always write which component is affecting AD, then refer to the graph.
Output Gaps
In order to understand what happens to the economy over a period of time, we need to
know where the short run equilibrium is relative to the full employment level of output.
Inflationary Gaps
If the short run equilibrium is such that the level of real GDP is above full employment level
output, we say that there is an inflationary gap (Y>Yf). This occurs when the productivity of
factors of production increases and they are overworked. However, this demands an
increase in factor incomes and therefore pushes prices up along with nominal GDP.
