ECO101H1 Lecture Notes - Lecture 11: Stagflation, Demand Shock, Output Gap
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ECO101H1 Full Course Notes
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If sras > ad (i. e. p > peq) inventories are increasing. Firms respond by decreasing production and driving down prices. If sras < ad (i. e p < peq) inventories are decreasing. Firms respond by increasing production and driving up prices. Ad = sras = potential gdp = y* The normal utilisation of factors of production do not vary with price level (therefore, perfectly inelastic) Short run equilibrium will not always equal to potential gdp: wages and factor prices are sticky (can not automatically adjust) -> sras at fixed input prices. If unemployed for a long time, will accept lower wages (downward pressure on wages) Self correcting mechanism helps getting sr eq to lr eq from pressure on wages. Output gaps put pressure on factor prices (ie wages) As factor prices change, the as will shift until the pressure is removed. As will shift until as = ad = y* Wages are rising -> inflationary gap is easier to correct.