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Equilibrium

Explore how equilibrium price and quantity are determined by the intersection of AD and AS curves, affecting output levels, employment, and price stability in the short and long run.

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Equilibrium

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  1. Equilibrium • Equilibrium price and quantity are found where the AD and AS curves intersect. • At any price level above equilibrium sellers are faced with surpluses and are forced to reduce production and price level. • At any price level below equilibrium buyers are faced with shortages and are forced to pay more, encouraging suppliers to produce more.

  2. Price Level Short-run aggregate supply Equilibrium price A Aggregate demand Quantity of Equilibrium output 0 Output Equilibrium

  3. Equilibrium • In the short run equilibrium may be above or below the full employment rate. In other words AD and AS may not intersect at the LRAS. • In the long run equilibrium will be at the LRAS, because in the long-run short run AS will have adjusted so that short-run aggregate output is equal to the potential output.

  4. Short-run Equilibrium Below Full Employment Potential Output (recessionary gap) LRAS Price Level AS PL1 AD Q1 FE RGDP

  5. Short run Equilibrium Above Full Employment Potential Output (inflationary gap) LRAS Price Level AS PL1 AD Q1 FE RGDP

  6. Changes in AD • Increases in AD cause the price level and the level of output and employment to rise. • This rise in price level is known as demand-pull inflation. • Decreases in AD cause the price level and the level of output and employment to fall. • Increases or decreases in AD are known asDemand Shocks

  7. Increases in AD LRAS Price Level AS PL2 PL1 AD2 AD Q1 FE RGDP ,Q2

  8. Changes in AS Increases in AS have a positive effect on both price level and output. • When AS shifts right, price levels fall or stabilize, but output increases.

  9. Increases in AS LRAS Price Level AS AS1 PL PL1 AD Q1 RGDP FE

  10. Changes in AS Decreases in AS have a negative effect on both price level and output. • When AS shifts left, price levels rise, but output falls. • This is known as cost-push inflation or stagflation. • Any unexpected change in AS whether positive or negative is known as a supply shock.

  11. Decreases in AS(stagflation) LRAS AS2 Price Level AS PL2 PL1 AD Q1 FE RGDP Q2

  12. Self-Correcting Nature of Economy • In the long-run aggregate supply will shift so that equilibrium will be at the long-run level of output • This happens as nominal wages and other input prices adjust to meet the current price level

  13. Short run Equilibrium Below Full Employment-Lower price levels lead to lower wages, shifting SRAS right LRAS Price Level AS AS2 PL1 PL2 AD Q1 FE RGDP ,Q2

  14. Short run Equilibrium Above Full Employment-Higher price levels lead to higher wages, shifting SRAS left LRAS AS2 Price Level AS PL1 AD1 FE Q1 RGDP

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