ECO102H1 Lecture 34: Lecture 34-Inflationary-Recessionary Gap (LRAS)

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copperclam445

1 Aug 2010

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Tuesday, March 2nd, 2010.

Yp: output when factors of production are utilized at normal rates

Short-Run Equilibrium: Alternative Cases

1. Y < Yp Recessionary gap

2. Y > Yp Inflationary gap

3. Y = Yp Full-employment (real GDP = potential GDP)

What will happen, in the long run, to:

1) The wage rate? FALLS (due to high unemployment)

2) The price level? FALLS (as SRAS shifts right)

3) Aggregate Demand? INCREASES (as price level falls)

4) Real GDP (Y)? INCREASES (to Yp)

Price Level

SRAS

Real GDP

Inflationary output gap

Price Level

SRAS

Real GDP

Recessionary output gap

Y< Yp

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Recessionary Gap: Self-Correction (in Long Run)

1. Yp ± Y0 = Recessionary Gap

2. Real GDP < Potential GDP =>

8QHPSOR\PHQW9

Wage rate ;HYHQWXDOO\

3. :DJH5DWH; !65$60 shifts right to SRAS1

(As costs of production fall, firms expand output)

4. Long-Run Equilibrium occurs at Yp

Summary

Short-Run

AD and SRAS determine real GDP

Time frame: say one year

Remember: factor prices are assumed to be a constant

Long-Run

Real GDP = LRAS (Potential GDP)

Time frame: several years or more

Implications

1. $'³VKRFNV´FKDQJHUHDO*'3LQshort-run, but not in long-run

2. Fiscal policy (for example) has different short-run and long-run impacts on real GDP

Example

Government increases expenditure (G) by $20 million.

SRAS0

LRAS

SRAS1

(w1 < w0)

Y< Yp

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Related Questions

If membership falls in labor unions and unions become less popular, then:

	production costs will increase, SRAS will shift to the left, decreasing equilibrium GDP and increasing the aggregate price level.
	production costs will fall, SRAS will shift to the right, increasing equilibrium GDP and lowering the aggregate price level.
	production costs will not change, AD will shift to the right, increasing equilibrium GDP and aggregate price level.
	production costs will fall, there will be a downward movement along SRAS, equilibrium GDP will increase and aggregate price level will fall.