What is the difference in the long run between a one-shot increase in aggregate demand and a one

What is the difference in the long run between a one-shot...

Key Concepts

Price Level Adjustment

Price level adjustment is a key mechanism in macroeconomics where shifts in demand or supply ultimately translate into changes in the general level of prices. In both scenarios—a one-shot AD increase and a one-shot SRAS decrease—the long-run outcome shows an elevated price level, serving as the primary difference in the long-run impact as real output is restored to potential.

Long-Run Equilibrium and Potential Output

Long-run equilibrium occurs when the economy's output is at its potential level, determined by underlying factors like technology, resources, and institutional settings. Both a one-shot AD increase and a one-shot SRAS decrease, after all adjustments, result in the economy returning to this potential output, while only the price level remains permanently altered.

Aggregate Demand (AD) Shift

This concept refers to a change in the total demand for goods and services in an economy at every price level. A one-shot increase in aggregate demand temporarily boosts output and employment in the short run, but in the long run, through adjustments in wages and prices, the economy returns to its potential output—with the primary long-term effect being a higher overall price level.

Short-Run Aggregate Supply (SRAS) Shift

This concept deals with changes in the production capacity of an economy in the short run, often due to factors like cost shocks. A one-shot decrease in short-run aggregate supply reduces output and increases the price level in the short run. However, as wages and expectations adjust over time, the SRAS eventually shifts back, leading the economy back to its natural output level, albeit at a higher price level.

Transcript

00:01 One thing the phillips curve and aggregate supply have in common is that they both have a short run and a long run.

00:08 So let's talk about the phillips curve first.

00:11 The long run phillips curve is a vertical line which displays no relationship between unemployment and inflation.

00:19 It shows the natural rate of unemployment.

00:22 So any point of this line, it's going to be unemployment the same, but inflation changes.

00:29 But the short run phillips curve is different.

00:32 Short -run phillips curve displays unemployment and inflation related inversely.

00:39 So here, there is high unemployment but low inflation, and here there is low unemployment and high inflation.

00:51 So let's have an example.

00:55 So basically, the economy is producing right here.

01:01 Okay? so that would be point one.

01:03 But let's say that the economy suffers through an inflationary gap, so it moves up here, where unemployment is lower than the natural rate of unemployment, and inflation is high.

01:15 So eventually, the short -run phillips curve will move to the right, and the point will go back on the long -run phillips curve, back to the natural rate of unemployment.

01:27 So though unemployment decreased for a second at short term, eventually it went back.

01:35 To natural rate of unemployment.

01:38 This is similar for aggregate supply.

01:42 In the long -run aggregate supply, the long -run aggregate supply displays no relationship between real gdp and price level.

01:53 Prices and wages are fully flexible, and it's at full employment...

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