Lecture 14
EQUILIBRIUM GDP AND PRICE LEVEL
1. Equilibrium in the goods market
- Intersection of DD and SS curves
- Eqbm GDP and price level
- Actual GDP vs Potential GDP
- High or low unemployment
- Recessionary gap or inflationary gap
2. Inflationary gap
- Excessive aggregate demand
- Actual GDP > Potential GDP
- Unemployment is less than the natural rate
2.1 Self correcting mechanism
- Inflationary gap does not last for long (why?)
- Long-run eqbm: Output = Potential GDP
3. Recessionary gap
- Does the self correcting mechanism work?
- Wage rigidity could lead to unemployment eqbm
- Justification for expansionary fiscal policy
- Cut taxes
- Increase govt. spending
4. Changes in GDP and price level
- Changes in parameters of DD and SS curves
- Draw graphs for each
4.1 Increase in interest rates
- Decline in consumption and investment (why?)
- Decrease in aggregate expenditure
- The DD curve shifts to the ...?
- Result: GDP falls; Price level falls
- Note: How much P falls will depend on the initial economic
situation
4.2 Improvement in labor productivity
- Same as improvement in technology (why?)
- Increase in aggregate supply (why?)
- Result: Increase in GDP; fall in P
- The best of both worlds!
5. Changes in Aggregate Supply
- Explanation for stagflation in the 1970s
- "The New Economy" of the 1990s
[ EC101 home ]