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Macroeconomics : Short and Long Run

Study Aid for future macroeconomics classes on specific aspects of macroeconomics.
by

Briana Watkins

on 25 May 2011

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Transcript of Macroeconomics : Short and Long Run

Aggregate Demand When one is focusing on Macroeconomics, the focus becomes on all goods and services produced by an economy. As a result of this, the demand for all individual goods and services is combined and referred to as the aggregate demand. The supply of all goods and services in the economy is called the aggregate supply. The aggregate demand curve represents the total quantity of all goods (and services) demanded by the economy at different price levels. Shifts in the Aggregate Demand curve A change in factors affecting any one or more components of aggregate demand, households (C), firms (I), the government (G) or Net Exports (NX) changes planned aggregate demand and results in a shift in the AD curve. Factors causing a shift in AD Changes in Expectations Current spending is affected by anticipated future income, profit, and inflation Changes in Monetary Policy –
i.e. a change in interest rates An expansionary monetary policy will cause an outward shift of the AD curve. If interest rates fall – this lowers the cost of borrowing and the incentive to save, thereby encouraging consumption. Lower interest rates encourage firms to borrow and invest. Changes in Fiscal Policy Fiscal Policy refers to changes in government spending, welfare benefits and taxation, and the amount that the government borrows Economic events in
the international economy International factors such as the exchange rate and foreign income (e.g. the economic cycle in other countries) Changes in household wealth A rise in house prices or the value of shares increases consumers’ wealth and allow an increase in borrowing to finance consumption increasing AD. In contrast, a fall in the value of share prices will lead to a decline in household financial wealth and a fall in consumer demand. Aggregate Supply Aggregate supply measures the volume of goods and services produced within the economy at a given price level. Put simply, aggregate supply represents the ability of an economy to produce goods and services either in the short-term or in the long-term. It tells us the quantity of real GDP that will be supplied at various price levels. The nature of this relationship will differ between the long run and the short run. Short Run Aggregate Supply Short Run Short run aggregate supply (SRAS) shows total planned output when prices in the economy can change but the prices and productivity of all factor inputs (e.g. wage rates) and the state of technology are assumed to be held constant.
In the short run, the aggregate-supply curve is assumed to be upward sloping Long Run Long run aggregate supply (LRAS): LRAS shows total planned output when both prices and average wage rates can change – it is a measure of a country’s potential output and the concept is linked strongly to that of the production possibility frontier.
In the long run, the aggregate-supply curve is assumed to be vertical Short Run Aggregate Supply Curve Changes in aggregate supply are represented by shifts of the aggregate supply curve. A shift to the right of the SAS curve from SAS1 to SAS2 of the LAS curve from LAS1 to LAS2 means that at the same price levels the quantity supplied of real GDP has increased. A shift to the left of the SAS curve from SAS1 to SAS3 or of the LAS curve from LAS1 to LAS3 means that at the same price levels the quantity supplied of real GDP has decreased Shifts of the Aggregate Supply Curves Shifts in Short Run Aggregate Demand Changes in unit labour costs Unit labour costs are defined as wage costs adjusted for the level of productivity. Commodity Prices Changes to raw material costs and other components e.g. the world price of oil, copper, aluminium and other inputs Government taxation and subsidy Changes to producer taxes and subsidies levied by the government as part of their fiscal policy. Long Run Aggregate Supply Shifts In the long run we assume that aggregate supply is independent of the price level. As a result we draw the long run aggregate supply curve as vertical. Drawing the LRAS as vertical, states that there is a maximum level of physical output that the economy can produce. Any change in the economy that alters the natural rate of growth of output (i.e. trend growth) shifts the long-run aggregate-supply curve.

Improvements in productivity and efficiency or an increase in the stock of capital and labour resources cause the LRAS curve to shift out. The result is that a great volume of national output can be produced at any given price level.
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