Short-run and long-run aggregate supply - publié le 22/01/2007

Résumé du document

One of the goals of economists is to try to predict the changes in the state of the UK economy. Thus they are interested in the economic growth –given by the growth of potential GDP-, the inflation and business cycle fluctuations. The Aggregate Supply – Aggregate Demand model permits to understand, and even to predict the changes in these three features of macroeconomic performance. Indeed this model permits to determine the level of real GDP and the price level when the economy is at its equilibrium. Thus, in this essay, we will use this AS-AD model to predict the effects on real GDP and price level of increases in American tourism to the UK. To do so, we will first have to describe how this model works both in the short and long-run. To understand the AS-AD model, we need to explain the concepts of short-term and long-term aggregate supply.

Extraits

[...] Figure 5 represents the shift of the short-term aggregate supply from SAS0 to SAS1. Figure Effects on price level and real GDP of an increase in aggregate demand, after a certain period of time. The short-run aggregate supply curve shifts until the point where it crosses the new aggregate demand curve (AD1) at full-employment equilibrium. This point is labelled C on figure 5. “Along the adjustment path [of the short-run aggregate supply curve], real GDP falls and price level rises”[7]. [...]

[...] Indeed this model permits to determine the level of real GDP and the price level when the economy is at its equilibrium. Thus, in this essay, we will use this AS-AD model to predict the effects on real GDP and price level of increases in American tourism to the UK. To do so, we will first have to describe how this model works both in the short and long-run. To understand the AS-AD model, we need to explain the concepts of short-term and long-term aggregate supply. [...]

[...] These shifts and their consequences are represented in figure 6.This process is called a is a pull-demand inflation, that is to say a general rise in the prices of goods and services which results from an initial increase in aggregate demand. So, the use of the aggregate supply aggregate demand model has permited to describe the effects on price level and real GDP of increases in American tourism to the UK. In the short term, it causes an increase in both price level and real GDP. This is a period were factors of production are more than fully employed. [...]

[...] In the long term, the aggregate supply is equal to this potential GDP. Indeed, even if economy is constantly bombarded with events that move real GDP away from potential the macroeconomic long-run is a period long enough to permit to the forces which makes real GDP equal to potential GDP to have done their work. The green curve on figure 1 represents the long-run aggregate supply curve: it shows the relationship between the quantity of real GDP supplied and the price level in the long term, when real GDP equals potential GDP. [...]

[...] As prices and production rise, the economy goes from point A to point B. So, in the short-run, an increase in American tourism causes an increase both in price level –which increases from PA to PB- and in real GDP –which increases from YA to YB. However, as this short-term equilibrium is an above full-employment equilibrium, this situation cannot last for long. Since prices have increased but wage rate has remained constant[6], the purchasing power of workers has decreased. There is a shortage of labour so firms have to accept to increase the wage rate in order not to lose workers. [...]