Macroeconomic Equilibrium Introduction Macroeconomic equilibrium for an economy in the short run is established when aggregate demand intersects with short-run aggregate supply. At the price level Pe, the aggregate demand for goods and services is equal to the aggregate supply of output. The output and the general price level in the economy will tend to adjust towards this equilibrium position. If the price level is too high, there will be an excess supply of output. If the price level is below equilibrium, there will be excess demand in the short run. In both situations there should be a process taking the economy towards the equilibrium level of output. Consider for example a situation where aggregate supply is greater than current demand. This will lead to a build up in stocks (inventories) and this sends a signal to producers either to cut prices (to stimulate an increase in demand) or to reduce output so as to reduce the build up of excess stocks. Either way - there is a tendency for output to move closer to the current level of demand. There may be occasions when in the short run, the economy cannot meet an increase in demand. This is more likely to occur when an economy reaches full-employment of factor resources. In this situation, the aggregate supply curve in the short run becomes increasingly inelastic. The diagram below tracks the effect of this. We see aggregate demand rising but the economy finds it difficult to raise (expand) production. There is a small increase in real national output, but the main effect is to put upward pressure on the general price level. Shortages of resources will lead to a general rise in costs and prices. Impact of a change in aggregate supply Suppose that increased efficiency and productivity together with lower input costs (e.g. of essential raw materials) causes the short run aggregate supply curve to shift outwards. (I.e. an increase in supply - assume no shift in aggregate demand). The diagram below shows what is likely to happen. AS shifts outwards and a new macroeconomic equilibrium will be established. The price level has fallen and real national output (in equilibrium) has increased to Y2. Aggregate supply would shift inwards if there is a rise in the unit costs of production in the economy. For example there might be a rise in unit wage costs perhaps caused by higher wages not compensated for by higher labour productivity. External economic shocksmight also cause the aggregate supply curve to shift inwards. For example a sharp rise in global commodity prices. If AS shifts to the left, assuming no change in the aggregate demand curve, we expect to see a higher price level (this is known as
There are a couple reasons why the aggregate-demand curve slopes downward. The first is the wealth effect. If the prices are higher, the money one has is worth less. It can be put into perspective by looking at it on a microeconomic level. For example, if you have a $20 bill, and the price for a ham sandwich rises from $5 to $10, you can only buy two sandwiches, rather than four. This shows that lower wealth leads to lower consumption, lower consumption leads to lower production, which means less workers will be need, leading to layoffs. The second reason is the interest-rate effect. As the prices rise, so do the interest rates. Higher interest rates hold down thing...
The United States is the leading economy across the globe and experienced several tribulations in the recent past following the 2008 global recession. Despite these recent challenges, there are expectations among policymakers and financial experts that the country will experience solid economic growth. Actually, financial analysts have stated that the U.S. economy will be characterized by increased consumer spending, increased investments by businesses, reduced rate of unemployment, and reduction in government cut. Some analysts have also stated that the country’s economy will strengthen in 2014 with an average of 2.7 percent or more. However, these predictions can only be understood through an analysis of the current macroeconomic situation in the United States.
A theme that dominates modern discussions of macro policy is the importance of expectations, and economists have devoted a great deal of thought to expectations and the economy. Change in expectations can shift the aggregate demand (AD) curve; expectations of inflation can cause inflation. For this reason expectations are central to all policy discussions, and what people believe policy will be significantly influences the effectiveness of the policy.
Robert E. Lucas Jr.’s journal article, “Some Macroeconomics for the 21st Century” in the Journal of Economic Perspectives, uses both his own and other economist’s models to track and predict economic industrialization and growth by per capita income. Using models of growth on a country wide basis, Lucas is able to track the rate at which nations become industrialized, and the growth rate of the average income once industrialization has taken place. In doing so, he has come to the conclusion that the average rate of growth among industrialized nations is around 2% for the last 30 years, but is higher the closer the nation is to the point in time that it first industrialized. This conclusion is supported by his models, and is a generally accepted idea. Lucas goes on to say that the farther we get from the industrial revolution the average growth rate is more likely to hit 1.5% as a greater percentage of countries become industrialized.
A movie that the characters of Brave New World would relate to would be Equilibrium. Equilibrium takes place after World War III, believing that human emotion was the cause of man’s inhumanity to man all forms of art and emotion were banned. Citizens are forced to take a drug called Prozium which suppresses emotions. In both societies, citizens depend on drugs for stability and peace. There is a connection between Preston and Lenina; both are the average good citizen. In Equilibrium after waking up from an emotional dream Preston is left with a sensation of strong emotional feelings. He was about to take a dose of prozium but stops and realizes he likes this feelin better than prozium. Likewise in Brave New World after meeting John, Lenina
In an economy, aggregate demand (AD) accounts for the total expenditure on goods and services. It has five constituents; Consumer expenditure (C), Investment expenditure (I), Government expenditure (G), Export expenditure (X) and import expenditure (M), This gives us: AD= C+I+G+X-M. Aggregate supply (AS) on the other hand is the total supply of goods and services in the economy. Increasing AD and decreasing AS both cause demand-pull and cost-push inflation respectively. Demand pull inflation occurs when aggregate demand (AD) continuously rises, detailed in Figure 1. The AD curve continuously shifts to the right, as demand continuously increases, from point a to b to c. This consequently causes an increase in the price level of goods and services. As prices rise, costs of production also increase, causing producers to reduce output (a decrease in aggregate supply (AS)), shifting the AS curve to the left and leading to yet another increase in prices, (t...
“Microeconomics and macroeconomics can be described in terms of small-scale vs. large-scale or in terms of partial vs. general equilibrium. Perhaps the most important distinction, however, is in terms of the role of equilibrium. While issues in microeconomics seldom challenge the notion of a naturally occurring equilibrium, the existence of business cycles and, especially, unemployment suggests too many observers that macroeconomics raises issues of a different character.” (McConnell & Brue, 2004).
Have you ever stopped to think, and ask yourself, “why is that so?” In society, there are a plethora of different peculiar phenomena that go on, yet they have become such a common part of our everyday lives that we usually do not stop to contemplate and formulate an answer to why things occur the way they do. For the most part, we tend to brush things off as, “it is what it is.” One phenomena that I have always found interesting pertains to relationships. It is, “why do celebrities have more unstable marriages than non-celebrity couples?” This is specifically concerning the topic of divorce. In society, I have noticed that there are more celebrity couples getting divorces and remarrying than there are non-celebrity couples. While no one usually pays any mind to this trend, there is an underlying explanation that can define the reasons why this tends to be true. Believe it or not, but this question can be answered in economic terms.
In the automobile industry, there are factors that cause a shift in the supply and price elasticity of the supply and demand. These factors can cause the supply demand to reduce or raise the demand for the automobiles. One factor to consider is if the price of steel rises. Automobile manufacturers will then produce fewer automobiles at all different price levels and the supply curve will then shift. Another factor to consider is if automobile workers decide to go on strike for higher wages. The company will be forced to pay more for labor to build the same number of automobiles. The supply of these automobiles will decrease. Lastly, another factor that can curve a shift in the supply curve could be if the government imposes a new tax on car manufacturers. In all of those cases, the supply curve will move because the quantity supplied is lower at all price levels.
In conclusion, generally speaking the Law of Supply states that when the selling price of an item rises there are more people willing to produce the item. Since a higher price means more profit for the producer and as the price rises more people will be willing to produce the item when they see that there is more money to be earned. Meanwhile the Law of Demand states that when the price of an item goes down, the demand for it will go up. When the price drops people who could not afford the item can now buy it, and people who are not willing to buy it before will now buy it at the lower price as well. Also, if the price of an item drops enough people will buy more of the product and even find alternative uses for the product.
This shifts the supply curve to the right, lowering price. The firms making losses leave the market, which shifts the curve to the left and raises price. Allowing the rest of the firms to earn normal profits, as shown in Figure 1&2.
It is difficult for government to achieve all the macroeconomics objectives at the same time. Conflicts between macroeconomics objectives means a policy irritating aggregate demand may reduce unemployment in the short term but launch a period of higher inflation and exacerbate the current account of the balance of payments which can also dividend into main objectives and additional objectives (N. T. Macdonald,
Difficulties in Formulating Macroeconomic Policy Policy makers try to influence the behaviour of broad economic aggregates in order to improve the performance of the economy. The main macroeconomic objectives of policy are: a high and relatively stable level of employment; a stable general price level; a growing level of real income (economic growth); balance of payments equilibrium, and certain distributional aims. This essay will go through what these difficulties are and examine how these difficulties affect the policy maker when they attempt to formulate macroeconomic policy. It is difficult to provide a single decisive factor for policy evaluation as a change in political and/or economic circumstances may result in declared objectives being changed or reversed. Economists can give advice on the feasibility and desirability of policies designed to attain the ultimate targets, however, the ultimate responsibility lies with the policy maker.
For instance, the cost for the resources needed by the industry may increase as production levels increase. This will make the long-run supply curve go up.
Because of the GDP growth too fast, increased wages of some citizens will lead to higher demand as consumers spend more freely. This will imply that the supply and demand will be increased and it will occur the shortage of supply. Business must hire more employees and further increasing demand by increasing wages. The increased demand will face of shortage supply and quickly forces prices up.