# ECON 102 Lecture Notes - Longrun, Shortage, Negative Relationship

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Endogenous Factors: Price Adjustments 02-27-2013

Time Frames in Economics

Defined not by length of time, but rather according to which variables are assumed to

change.

Short run

Factor Price Adjustment Period

Long Run

Short Run Assumptions

Factor prices are exogenous ex. fixed

Technology and Factor Supplies are constant – affects Y*

o PPB is fixed; therefore, Potential Output is also constant

Exogenous shocks to supply and demand cause fluctuation around Y*

In the short run, equilibrium, is determined by the intersection of the AS and AD curves

Factor Price Adjustment Assumptions

Factor prices are flexible and adjust to output gaps

Technology and factor supplies are constant

Long run equilibrium occurs when AS = AD and factor prices are fully adjusted

Long Run Assumptions

Factor prices have fully adjusted to output gaps

o Therefore, there are no more output gaps (eliminated)

o Real GDP = Potential level

Technology and Factor Supplies are changing

Output Gaps and Factor Prices

Recessionary Gap

Short run equilibrium – where two curves cross

But Y0 < Y* recessionary gap

Relationship between recessionary gap and intensity of resource use: some

resources are sitting idle that can possibly be productive

o Firms producing below potential output

o Demand for factors of production is low

If the demand for a commodity decreases, the demand for the factors of that

commodity decreases as well.

As the factor prices fall, AS curve shifts to the right Real GDP returns to its

Potential Level (Y*)

Summary:

1. In a recessionary gap, resources are underutilized some factors are idle

2. There is an over-supply of factors

3. This puts downward pressure on factor prices

4. Which decreases unit costs for firms

5. AS increases and shifts to the right

Exam question: Explain the factor price adjustment process in a recessionary

gap.

Points 1,3,4,5 – Complete answer

Inflationary Gap

Real GDP is above Potential GDP

Resources are being over-utilized – firms are demanding more resources than

people want to supply (ex. everyone working 45 hours a week)

Excess demand for factors (labour) upward pressure on price of wage AS

falls

Summary:

## Document Summary

Defined not by length of time, but rather according to which variables are assumed to change. Technology and factor supplies are constant affects y: ppb is fixed; therefore, potential output is also constant. Exogenous shocks to supply and demand cause fluctuation around y* In the short run, equilibrium, is determined by the intersection of the as and ad curves. Factor prices are flexible and adjust to output gaps. Long run equilibrium occurs when as = ad and factor prices are fully adjusted. Factor prices have fully adjusted to output gaps: therefore, there are no more output gaps (eliminated, real gdp = potential level. Short run equilibrium where two curves cross. But y0 < y* recessionary gap. Relationship between recessionary gap and intensity of resource use: some resources are sitting idle that can possibly be productive: firms producing below potential output, demand for factors of production is low.