Macroeconomic equilibrium occurs when aggregate supply and demand meet

Interpreting the aggregate demand/aggregate supply model (article) | Khan Academy

macroeconomic equilibrium occurs when aggregate supply and demand meet

Analyze aggregate demand and supply in the long run In economics, equilibrium is a state where economic forces (supply and demand) are balanced. It is represented on the AS-AD model where the demand and supply curves intersect. The aggregate demand/aggregate supply model is a model that shows what and how total demand and total supply interact at the macroeconomic level. and aggregate demand, AD, curves intersect, showing the equilibrium level of real. The Aggregate Demand and Aggregate Supply equilibrium provides to unemployment, inflation, and growth as a result of new economic policy. The Aggregate Supply curve is horizontal until it reaches the point of full.

macroeconomic equilibrium occurs when aggregate supply and demand meet

Let's begin by walking through the elements of the diagram one at a time: The aggregate supply curve The graph shows an upward sloping aggregate supply curve.

The slope is gradual between 6, and 9, before become steeper, especially between 9, and 9, The vertical axis shows the price level. Price level is the average price of all goods and services produced in the economy. It's an index number, like the GDP deflator. Notice on the graph that as the price level rises, the aggregate supply—quantity of goods and services supplied—rises as well.

Why do you think this is? The price level shown on the vertical axis represents prices for final goods or outputs bought in the economy, not the price level for intermediate goods and services that are inputs to production.

Interpreting the aggregate demand/aggregate supply model

The AS curve describes how suppliers will react to a higher price level for final outputs of goods and services while the prices of inputs like labor and energy remain constant. If firms across the economy face a situation where the price level of what they produce and sell is rising but their costs of production are not rising, then the lure of higher profits will induce them to expand production.

Potential GDP If you look at our example graph above, you'll see that the slope of the AS curve changes from nearly flat at its far left to nearly vertical at its far right. At the far left of the aggregate supply curve, the level of output in the economy is far below potential GDP—the quantity that an economy can produce by fully employing its existing levels of labor, physical capital, and technology, in the context of its existing market and legal institutions.

Aggregate demand and aggregate supply curves

At these relatively low levels of output, levels of unemployment are high, and many factories are running only part-time or have closed their doors. In this situation, a relatively small increase in the prices of the outputs that businesses sell—with no rise in input prices—can encourage a considerable surge in the quantity of aggregate supply—real GDP—because so many workers and factories are ready to swing into production.

As the quantity produced increases, however, certain firms and industries will start running into limits—for example, nearly all of the expert workers in a certain industry could have jobs or factories in certain geographic areas or industries might be running at full speed.

In the intermediate area of the AS curve, a higher price level for outputs continues to encourage a greater quantity of output, but as the increasingly steep upward slope of the aggregate supply curve shows, the increase in quantity in response to a given rise in the price level will not be quite as large. At the far right, the aggregate supply curve becomes nearly vertical. At this quantity, higher prices for outputs cannot encourage additional output because even if firms want to expand output, the inputs of labor and machinery in the economy are fully employed.

In our example AS curve, the vertical line in the exhibit shows that potential GDP occurs at a total output of 9, When an economy is operating at its potential GDP, machines and factories are running at capacity, and the unemployment rate is relatively low at the natural rate of unemployment. The aggregate supply curve is typically drawn to cross the potential GDP line. This shape may seem puzzling—How can an economy produce at an output level which is higher than its potential or full-employment GDP?

The economic intuition here is that if prices for outputs were high enough, producers would make fanatical efforts to produce: Such hyper-intense production would go beyond using potential labor and physical capital resources fully to using them in a way that is not sustainable in the long term.

Thus, it is indeed possible for production to sprint above potential GDP, but only in the short run. While they may have superficial resemblance, their underlying differences are much greater. For example, the vertical and horizontal axes have distinctly different meanings in macroeconomic and microeconomic diagrams.

Macroeconomic Equilibrium

The vertical axis of a microeconomic demand and supply diagram expresses a price—or wage or rate of return—for an individual good or service. This price is implicitly relative; it is intended to be compared with the prices of other products—for example, the price of pizza relative to the price of fried chicken. In contrast, the vertical axis of an aggregate supply and aggregate demand diagram expresses the level of a price index like the Consumer Price Index or the GDP deflator—combining a wide array of prices from across the economy.

The price level is absolute: The horizontal axis of a microeconomic supply and demand curve measures the quantity of a particular good or service.

In contrast, the horizontal axis of the aggregate demand and aggregate supply diagram measures GDP, which is the sum of all the final goods and services produced in the economy, not the quantity in a specific market.

In addition, the economic reasons for the shapes of the curves in the macroeconomic model are different from the reasons for the shapes of the curves in microeconomic models. Demand curves for individual goods or services slope down primarily because of the existence of substitute goods, not the wealth effects, interest rate, and foreign price effects associated with aggregate demand curves.

macroeconomic equilibrium occurs when aggregate supply and demand meet

Individual supply and demand curves can have a variety of different slopes, depending on the extent to which quantity demanded and quantity supplied react to price in that specific market, but the slopes of AS and AD curves are much the same in every diagram—short-run and long-run perspectives emphasize different parts of the AS curve. The intuitions and meanings of macro and micro diagrams are only distant cousins in the economics family tree.

The table below gives information on aggregate supply, aggregate demand, and the price level for the imaginary country of Xurbia.