Explain the relationship of the long-run aggregate supply curve, the short-run aggregate supply curve and the aggregate demand curve in determining a long-run and short-run macroeconomic equilibrium. (10 marks)
The curves represent two aggregate short run aggregate supply (SRAS) and long run aggregate supply (LRAS). Short run aggregate supply (SRAS) is price level of total output in a time period will remain the same. The SRAS will response to producers as high demands in the economy that makes the price level to increase and leads to increase in profit and real output, thus making an economic growth..
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Aggregate Demand is a curve that shows the total demand for goods and services in the economy at a price level. The curve is slop downward since it has an inverse between the aggregate output and the pricing level.
In the long run equilibrium (LRE), the economy prices of all factors of production like wage rates and other factor prices to have adjusted to any disturbances so that the quantities demanded and supplied are equal in all markets. For LRE to shift is when there is an increase in quantity and productivity of factors of production or an advance in technology cause an increase in the productive potential of the economy. But also the LRE is able to achieve full employment since the LRE intersect with the GDP and price of the aggregate demand. At this point the LRE lies on the long run aggregate supply curve and in a result an increase in aggregate output.
Short run equilibrium prices of goods and services change in responds to changes in demand and supply but the factors of production such as wage rates and the prices of raw materials do not change. This is due to wages rate in labour change slowly than price levels and the price of raw materials keeps has a small impact like oil since producers will keep the price steady but at the same time or period it will change in a huge amount difference. At the price level equilibrium, the aggregate demand for goods and services is equal to the aggregate supply of output.Â The output and the general price level in the economy will tend to adjust towards this equilibrium position. But no matter the price level increase or decreases the economy will be taken to a equilibrium level of output. For example if the aggregate supply is greater than current demand. This will lead to a supply of stocks and this will make producers either to cut prices so they can increase in demand or to reduce output so there is less supply stock in the producers. Either way there is a tendency for output to move closer to the current level of demand.
From short run aggregate supply to the long run aggregate supply shifting towards the right side will cause an aggregate output to decrease. Thus making the AS curve to shift right but is all due to an adjustment in the economy and this will have an fall in wages as it shift right.
The relation between the two equilibrium is that they both go the other way round, if there is a recessionary gap, the aggregate output is below the potential output it suppose to be and the other is the inflationary gap which the aggregate output is higher than the potential output. With these it can cause rise in wages with lowing price level and aggregate output and reducing unemployment rate for the inflationary gap.
What happens if the economy is at its long-run equilibrium and aggregate demand increases? (5 marks)
When the economy is at its long run equilibrium, it is operating near full employment. This will cause the economy to increase in aggregate demand of goods and services thus shifting the equilibrium to another point, at the point of time firms canâ€™t increase their output since they have reach its full capacity and that they have to buy other raw resources from other country or get more labour which will also increase cost. The effect will therefore increase in demand doesnâ€™t increase a lot in the output (economic growth) but rather result in the price level of available product going up, so when increasing aggregate demand the economy will suffer high inflation and a little bit of economic growth.
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If the long run aggregate supply shifts right, that means the government has implement expansionary monetary policy or fiscal policy which allows the aggregate demand curve to shift but with these policies it can take a long time for it to fully take effect. Once the policy is fully effect, the economy will began to change as firms will be more efficient and more comparative. It will also decrease inflation rate of price level which the economy will be able produce and less pressure to push up prices. This will cause an increase in the output that will increase economic growth.
Long run equilibrium can cause the aggregate demand to increase but the economic will have a slow growth and high inflation.
A shift in aggregate supply can change the aggregate output and price level in the economy.