Aggregate Supply & Demand Model Part 2

1. Aggregate Supply & Demand Model Part 2 Long Run AS Curves

2. Using AS/AD Model • How can you improve the current economy? U.S. Economy Gov’t ↓ Taxes => consumer income ↑ C ↑ => AD ↑ => R-GDP ↑ Price Level AS1 --------------- -------------------- P2 P1 E1 E2 --------------- Opportunity Cost? Rising Gov’t Debt (risk of crowding out) AD1 ------------------ Y1 Real GDP Y2 AD2

3. PPF Review • Illustrates the full potential of an economy On PPF Line means: • Unemployment low as possible (4.0%) • Jobs match human capital • Economy as efficient as possible AS/AD Model Price Level AS1 P1 -------------- E1 -------------- AD1 Q1 Real GDP

4. Aggregate Supply Curves • Short runcurve (SRAS) is upwardsloping • Long Run curve (LRAS) is vertical at full potential output

5. Full Potential Output • Level of Real GDP economy achieves in long run is based on a country’s full potential to produce goods/services What determines full potential?

6. Short Run Equilibrium • In the short run an economy can be at, above, or below full potential • In theory, in the long run => economy must be at full potential Full Potential Output Equilibrium On PPF Curve Unemployment low as possible Jobs match human capital Economy as efficient as possible

7. Full Potential Worksheet Long Run Equilibrium P1 ----------------- E1 Y1

8. Recessionary Gap Economy above full output LRAS1 LRAS1 Price Level Price Level SRAS1 SRAS1 Real GDP Real GDP AD1 AD1 Inflationary Gap Economy below full output ----------------- P1 E1 ----------- E1 P1 -------------- --------- Y* Y1 Y1 Y* Unemployment high, real output low Below PPF, idle resources Unemployment very low, output high Above PPF, no idle resources

9. How to produce more! • As PPF shifts right => full potential ↑ => LRAS shifts right