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Long Run Macroeconomics Dynamics

Explore the self-correcting nature of the economy in the long run, from expansionary gaps to contractionary gaps, and equilibrium principles. Learn how wage contracts, resource prices, and aggregate demand affect macroeconomic stability.

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Long Run Macroeconomics Dynamics

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  1. Chapter 8 Long Run Macroeconomics – The Self Correcting Economy

  2. Long Run • Period where wage contracts and resource prices are flexible

  3. Expansionary Gap • Expansionary Gap = Actual GDP > Natural (Potential) GDP (inflationary) • AD or AS shifts to the right causing the gap • Overemployment exists • Overtime work, Greater than capacity capital use, labor in short supply • As wage contracts end they are renegotiated at a higher rate • Wages rise • Costs rise for firms • Firms produce less • SRAS shifts to the left to the Potential GDP • Incomes fall

  4. Contractionary Gap • Contractionary Gap = Actual GDP < Natural (Potential) GDP (unemployment) • AD or AS shifts to the right causing the gap • Unemployment exists • Idle workers, lower than capacity capital use, labor in great supply • As wage contracts end they are renegotiated at a lower expected inflation rate • Wages fall • Costs fall for firms • Firms produce more • SRAS shifts to the right to the Potential GDP • Incomes began to rise

  5. Long Run Aggregate Supply (LRAS) • Vertical at the Potential GDP • Outward shift in the PPC causes the LRAS to shift leftward • Long Run Equilibrium • Actual Price level = Expected Price level • Actual GDP = Potential GDP • Qs = Qd • Long Run Aggregate Supply is Vertical at the Potential GDP, no price surprises

  6. Problems • Wages don’t decrease but they do • Takes to long to self-correct (6 years)

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