Unit 2.2 Macroeconomics

1. Aggregate Demand (AD)

Aggregate demand is the total demand for all final goods within a national economy; it consists of an inverse variation between real output (real GDP) and aggregate price level. The slope of the AD curve comes from the wealth effect, which states that lower price levels make consumers relatively wealthier and more eager to spend. Other factors include the interest rate effect and the international trade effect. Altogether, the components of aggregate demand are the expenditures of households, investments, governments, and foreigners. Consumption spending maybe be influenced by tax burdens and consumer confidence, investment spending by technological innovation and debt, government spending by political prioritization, and foreign spending considering tariffs and exchange rates. Overall determinants include interest rates, regulation, and protectionist policy. Implementations that limit AD influence a leftward shift of the curve.

2. Aggregate Supply (AS)

Aggregate supply refers to the total output of goods within a national economy; its curve features a positive relationship between price level and total output, for firms will produce more as potential profits increase (a positive relationship). It may be classified as either short run or long run when analyzed over certain periods of time. Movement along the AS curve is typically motivated by changes in factors of production, as these determine the ability of firms to adjust output to a certain point of intersection with aggregate demand. Exact position of the curve is usually determined by the ability of firms to acquire new factors of factor; for example, government taxation on petroleum would hinder national industry by increasing expenses for logistical factors.

7. Equilibrium in the Keynesian Model

For the Keynesian model of LRAS, there are three distinct equilibrium points indicative of economic performance (located in sections I, II, and III) demonstrating the capacity of the economy. Within section I, also identified as the Keynesian range, the intersection with AD signifies space capacity, as resources are not utilized to full extent. Aggregate demand is insufficient to actually affect price level. Such unemployment results in a recessionary gap, with equilibrium real output falling in front of potential output at full employment. Within section II, the curve begins to slope upwards as maximum employment is reached. This is where potential output is met by the real output at equilibrium, and it is the optimal position for national economies. Finally, an equilibrium point in section III demonstrates an inflationary gap, as AD in sufficient enough to raise price level. Employment and aggregate output are both above the potential. Overall, the Keynesian model illustrates aggregate demand being the crucial factor in influencing long run aggregate supply, resulting in changes in price level and quantity within specific regions of inflation and recession.

4. Alternative Views of Long Run Aggregate Supply (LRAS)

Long run aggregate supply often refers to the average AS over an extended period of time where factors of production can be adjusted. However, the appearance of the LRAS curve is often debated. The new classical perspective of LRAS states that output remains fixed at a point where all resources are fully employed; the factors of production themselves influence price level. Therefore, the monetarist LRAS curve is perfectly inelastic at a certain quantity due to price level demanded not being the decisive factor in real output. On the other hand, the Keynesian long run aggregate supply model describes LRAS as being perfectly elastic due to wages and prices remaining static at spare capacity, with price level being independent of quantity (referred to as the Keynesian range) due to unemployment. This leads to the intermediate range, where full employment is reached and the curve slopes upward, ending with the classical range, where AS is once again inelastic. The Keynesian model demonstrates the capacity to which economies are operating.

3. Short Run Aggregate Supply (SRAS)

Short run aggregate supply refers to aggregate supply over a period of time where new factors of production cannot be acquired. Firms can only maximize the output of what they currently possess, but nonetheless do so to meet aggregate demand. SRAS is usually influenced by short-term and immediate events, such as changes in minimum wage, adjustment of tariffs, and cataclysms. Therefore, it features some extent of elasticity as firms will adjust supply to reach new aggregate price levels. On an AD-AS graph, a short run aggregate supply curve to the left of LRAS at a certain aggregate price level signifies a recession, an instance where factors of production are not fully employed to achieve the historical average. An SRAS curve to the right of the long run counterpart demonstrates a period of inflation, where production is maximized and employment is above normal levels.

5. Short Run Equilibrium

Similar to microeconomics, short run equilibrium is where aggregate demand and short run aggregate supply intersect at a total output and aggregate price level on the AD-AS graph. At any total output besides short run equilibrium, the resulting disparity would create shortages of surpluses. It should be noted that SRAS is of greater significance in the context of economic analysis due to it being able to fluctuate and change equilibrium over comparably short periods of time. A long run equilibrium would have a constant quantity due to the inelastic nature of LRAS. Conversely, the position of the short run equilibrium is often compared to the LRAS curve. If equilibrium is to the left of LRAS, there is a recession as economic performance is below average. If it is to the right of long run aggregate supply, inflation is occurring, with far more rapid economic growth than usual. Therefore, the optimal position for the short run equilibrium is on the LRAS curve, signifying the performance of the economy to be the average.

6. Equilibrium in the New Classical Model

The new classical model states that equilibrium in the long run will feature a constant real output. Since the supply-side perspective holds LRAS to remain inelastic at a certain quantity, equilibrium can only move vertically along the curve. So, aggregate demand can only influence aggregate price level, not real gross domestic product, over significant periods of time. Therefore, the output of long run aggregate supply remains at its potential and is always maximized. Unlike the Keynesian model, which combines the inflationary and recessionary gaps of the short run into the AS curve, the monetarist perspective believes that given a sufficient period of time, such gaps will be eliminated due to the factors of production affecting the real output of LRAS, not AD. This is because the national economy cannot undergo extensive periods of either in the long run, so there must be movement around one, inelastic aggregate supply curve that results in an average real output.