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Comparing Short-Run and Long-Run Equilibrium in Aggregate Demand and Supply

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This document explores the differences between short-run and long-run equilibrium points in aggregate demand and supply. It examines how prices are defined as sticky in the short run, requiring adjustments in interest rates and output to restore equilibrium. Conversely, in the long run, prices are flexible, allowing the economy to self-adjust back to full employment without government intervention. Understanding these concepts is crucial for grasping economic policy implications and how economies react under different conditions.

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Comparing Short-Run and Long-Run Equilibrium in Aggregate Demand and Supply

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  1. Aggregate Demand and Aggregate Supply Comparison of Short Run and Long Run Equilibrium Points

  2. Learning Objectives • Understand the difference between short-run equilibrium and long-run equilibrium • Understand the difference between transmission mechanisms that re-equilibrate the economy in the short-run and in the long-run.

  3. The Short Run and the Long Run LRAS P r LM(P2) LM(P1) S P2 S r1 P1 r2 L L IS AD 0 Y* Y 0 Y Y* Y

  4. Short Run and Long Run: • The difference between the short-run approach and the long-run approach is the assumptions made about P and Y. • In the short-run we assume that prices are sticky; ie., they do not adjust quickly to changes in the economy. • This means that r and Y must adjust to bring the model back to equilibrium.

  5. Short Run and Long Run: • Short-run assumptions are reflected in point S. • Prices do not adjust so Y can be less than full employment Y, even while there is equilibrium in both markets. • The policy implication is that government intervention is required to reach full employment.

  6. Short Run and Long Run: • The difference between the short-run approach and the long-run approach is the assumptions made about P and Y. • In the long-run we assume that prices are flexible; ie., they adjust to changes in the economy. • This means that P must adjust to bring the model back to equilibrium.

  7. Short Run and Long Run: • Long-run assumptions are reflected in point L. • Prices change so the economy self-adjusts back to full employment Y. • The policy implication is that no government intervention is required to reach full employment.

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