Macroeconomic Equilibrium (AQA A Level Economics)

Short-run Macroeconomic Equilibrium

• Real national output equilibrium occurs where aggregate demand (AD) intersects with short-run aggregate supply (SRAS)

Diagram: Classical Short-run Equilibrium

Diagram analysis

• This economy is in short run equilibrium at AP₁Y₁

• Any changes to the components of AD will cause the AD curve to shift left or right, creating a new short-run equilibrium

• Any changes to the determinants of SRAS will shift the SRAS curve left or right, creating a new short-run equilibrium

Long-run Macroeconomic Equilibrium

• Free market economists believe that the economy will always return to its normal capacity level of output

  • In the short-run, there will be fluctuations around this capacity level of output

  • In the long-run, the economy will return to this normal capacity level of output, but perhaps at a different average price level

• It is important to understand the long-run macroeconomic equilibrium as it is used to identify positive and negative output gaps in an economy (this is covered in more detail in Section 11)

Diagram: Long-run Macroeconomic Equilibrium

Diagram analysis

• The LRAS curve demonstrates the normal capacity level of output of the economy using all of its scarce resources

• The SRAS intersects with AD at the LRAS curve

• This economy is producing at the full employment level of output (Y_FE)

• The average price level at Y_FE is AP₁

Aggregate Demand & Supply Analysis

1. An Increase in Aggregate Demand (AD)

Diagram: The Impact of Increasing AD

Diagram analysis

• The initial equilibrium level of output was at AP₁Y₁

• An increase in one of the components of AD (e.g. consumption) causes the AD to increase AD₁→AD₂

• Average prices in the economy rise to AP₂ and the real level of output increases to Y₂

• The new short-run equilibrium is at AP₂Y₂
  

2. An increase in short run aggregate supply (SRAS)

Diagram: The Impact of Increasing SRAS

Diagram analysis

• The initial equilibrium level of output was at AP₁Y₁

  • This equilibrium represents a negative output gap equal to Y₁Y_FE

• An increase in one of the determinants of SRAS (e.g. productivity) causes the SRAS to increase SRAS₁→SRAS₂

• Average prices in the economy fall to AP₂ and the real level of output increases to Y₂

• The new short-run equilibrium is at AP₂Y₂

• There is still a negative output gap but it is smaller (Y₂Y_FE)

Impact of Demand Side & Supply Side Shocks

• An economic shock is an unpredictable event that has macroeconomic consequences

  • They can have widespread positive or negative impacts on economic growth, inflation rate, unemployment levels 

• The type of shock is classified by the sector it originates from 

  • Demand side shock: typically involves a sudden change in the levels of private spending, as seen in shifts in consumer spending or business investment

  • Supply side shock: When production across an economy is made more difficult

  • Both demand and supply side: the economy faces challenges on both the consumption and production fronts 

A Table of Explaining Macroeconomic Shocks in the UK Economy