The concept of macroeconomic equilibrium

Macroeconomic equilibrium happens when the total amount of goods and services demanded in an economy matches the total amount supplied. This balance is shown by the point where the aggregate demand (AD) curve crosses the aggregate supply (AS) curve, setting a particular level of prices and overall output.

How shifts affect equilibrium

Any movement in either the AD or AS curve changes the equilibrium point, leading to new levels of prices and output. These changes influence key economic measures, such as growth, unemployment rates, inflation, and the balance of payments position. The government's main economic goals—achieving steady growth, keeping unemployment low, maintaining stable prices, and balancing international payments—are all impacted differently depending on which curve shifts.

Differences between short-run and long-run aggregate supply

• The short-run aggregate supply (SRAS) curve slopes upwards, meaning higher prices encourage more production in the short term.
• The long-run aggregate supply (LRAS) curve is vertical, showing that over time, output stays at the economy's full capacity regardless of price changes.
• An increase in AD boosts output only temporarily in the short run, with varying effects based on the AS curve's slope.

Effects of shifts in aggregate demand

Changes in aggregate demand alter the economy's balance, affecting prices, production, jobs, and trade. These shifts can create demand-pull inflation or lead to economic slowdowns.

Consequences of an increase in aggregate demand

• The AD curve moves right, creating a new equilibrium with higher prices and greater output.
• Higher output raises the need for resources, creating more jobs and lowering unemployment.
• Prices go up, causing demand-pull inflation.
• The rise in prices can harm the balance of payments by making exports less competitive and imports more attractive.

Consequences of a decrease in aggregate demand

• The AD curve shifts left, leading to lower output and higher unemployment as fewer jobs are needed.
• Prices tend to drop, which can ease inflation but may signal economic weakness.
• Overall, this worsens growth and could improve the balance of payments if imports fall more than exports.

The influence of spare capacity on the multiplier effect

Spare capacity refers to unused resources in the economy, like idle factories or unemployed workers. It affects how much an initial increase in spending can multiply through the economy.

How spare capacity limits the multiplier

The multiplier effect from a rise in AD is restricted if the economy lacks spare capacity, as supply cannot easily expand to meet extra demand. Without enough capacity, further demand increases lead to limited growth and higher inflation instead of broad expansion.

Effects based on aggregate supply elasticity

• High elasticity (plenty of spare capacity) - The AS curve is relatively flat, allowing a shift in AD to cause a large increase in output through the full multiplier effect.
• Low elasticity (limited spare capacity) - The AS curve is steep, so the same AD shift results in a small output rise but a sharp increase in prices and inflation.

Effects of shifts in aggregate supply

Movements in the aggregate supply curve impact a range of key economic indicators—growth, unemployment, inflation, and balance of payments—in the same direction, either improving or worsening them together.

Outcomes of an increase in aggregate supply

• The AS curve shifts right, expanding the economy's capacity and boosting output, which supports economic growth.
• More jobs are generated, reducing unemployment.
• Prices generally decrease, helping to control inflation.
• The economy gains international competitiveness, potentially improving the balance of payments through stronger exports.

Outcomes of a decrease in aggregate supply

• The AS curve shifts left, reducing output and slowing growth.
• Unemployment rises as fewer jobs are available.
• Prices increase, leading to higher inflation.
• Competitiveness falls, which can worsen the balance of payments.

Long-run aggregate supply shifts

• An increase in LRAS raises output and lowers prices while keeping the economy at full employment.
• It can also strengthen the balance of payments by making goods more affordable abroad.
• A decrease in LRAS has the opposite effects, harming all indicators.

Keynesian views on aggregate supply changes

Keynesian economists see the long-run aggregate supply curve as L-shaped, with effects of demand and supply shifts varying based on the economy's current state.

Impacts of aggregate demand increases in Keynesian theory

• At full capacity - Output stays the same, but prices rise significantly.
• During a depression - Output increases without much change in prices, as there is plenty of spare capacity.
• Just below full capacity - Both output and prices go up moderately.

Impacts of aggregate supply increases in Keynesian theory

The effect depends on where the AD curve intersects the Keynesian LRAS. In a deep downturn, boosting AS may not change the equilibrium, output, or jobs, as demand is too low. At higher demand levels, an AS increase can shift the equilibrium, potentially raising output and lowering prices. In the middle range, there might be no equilibrium change at all.

Policy implications in Keynesian economics

Increasing LRAS is key to improving a range of key economic indicators at once. However, during a depression, raising AS alone is ineffective, as it won't boost output or employment without also addressing demand.