IB Economics 3.2.9 Macroeconomic Equilibrium Notes

Short-run Equilibrium

In the short run, the economy is in equilibrium when the aggregate demand (AD) curve intersects the short-run aggregate supply curve (SRAS).

As can be seen in Figure 1 above, the AD and SRAS curves intersect at:

1. Equilibrium price ($PL_e$) ($PL_e$)
2. Equilibrium real output ($Y_e$)

The economy is at equilibrium when the AD and SRAS curves intersect because:

1. $PL_e$$PL_e$, such as $PL_1$:
   1. There would be an excess of real output produced and not demanded.
   2. This would encourage producers across the economy to reduce the final price of goods and services, decreasing the price level.
   3. With fixed costs of production and lower profit margins, producers reduce their output.
   4. This downward pressure on the price level persists until SRAS meets AD$PL_e$, $Y_e$.$PL_e$, $Y_e$.
2. $PL_e$$PL_e$, such as $PL_2$:
   1. There would be an excess amount of real output demanded and not produced.
   2. This would encourage producers across the economy to increase the final price of goods and services. This would increase the price level.
   3. As the price level rises, the quantity demanded gradually decreases, and the quantity supplied increases, moving the economy toward equilibrium.
   4. This upward pressure on the price level persists until SRAS meets AD at $PL_e$, $Y_e$.

Shifts in AD / SRAS: a new equilibrium

If there is a shift in AD / SRAS due to a change in one of their determinants, a new equilibrium price level and real output is set.

Figure 2 above shows two possible hypothetical shifts of an initial AD curve (AD1).

1. Originally:
   1. Equilibrium occurs when AD1 meets SRAS.
   2. Equilibrium price level = PL1
   3. Equilibrium real output = Y1
2. Rightward shift of AD (AD1→AD2):
   1. Now, SRAS meets AD2 at a new equilibrium.
   2. Equilibrium price level = PL2 (increase from PL1→PL2)
   3. Equilibrium real output = Y2 (increase from Y1→Y2)
3. Leftward shift of AD (AD1→AD3):
   1. Now, SRAS meets AD3 at a new equilibrium.