Chapter 25: the difference between short run and long one macroeconomics
25.1 Two examples from a recent history
Read it from the power point
25.2 accounting for changes in GDP
The simplest illustration of the distinction between short run and the long-run changes in
economic activity is the behavior of them real GDP over time.
Actual GDP is measured by statistics Canada
Potential GDP is a level of output that the economy produces when all factors of production are
being utilized at their normal rates. But statistics Canada can’t tell us the value of potential GDP
because it is not an observed variable—it to muster the estimated.
The value of potential GDP is estimated by combining three pieces of information: the amounts
of a veil of all factors of production such as the labour force and the capital stock; an estimate of
these factors’ normal rates of utilization; and an estimate of each factors’ productivity.
When studying long-run trends in GDP, economists focus on the change in potential output.
When studying long-run fluctuations, economists focus on the change in the output gap.
In our micro model, output is determined in the short run by the AD and AS curve but in the
long-run only by the level of Y*.
GDP Accounting: the basic principle
To break of GDP into the parts we want to study, reading the following obvious about useful
1. GDP= GDP
Next we multiplying the right hand side of the equation by F/F, where F is the economy’s total
available stock of factors such as land, labor and capital, this gives
2. GDP= F x (GDP/F)
Now we multiply and then right hand side by Fe/Fe, where Fe is the number of economy’s
factors that are employed. After meeting ordering the terms we have.
3. GDP= F x (Fe/F) x (GDP/Fe)
This a equation implies that we have added together units of labour and land and capital to get
a meaningful number of economy’s available factors, F. This is not actually possible since
different factors are rationed in different units.
In the next section, we will focus on a single factor to avoid this problem. For now however our
point is simplified by thinking about the economy’s total variable factors F. And the number of
those factors are employed, Fe.
The three components of the equation are:
1. F is the economy’s factor supply; it is the total amount of all factors of production that the
economy currently possesses.
2. Fe/F is the factory utilization rate; it is the fraction of the total supply of factors that is
actually used or employed at any time
3. GDP/Fe is a simple measure of productivity because it shows the amount of output (GDP)
per unit of input is employed (Fe).
This equation does nothing more than separate any change in GDP into a change in one or more
of the three components, F, Fe/F, or GDP/Fe
Any change in GDP can be decomposed into a change in factor supply, a change in factor
utilization, and a change in productivity. Factor supply and productivity change mostly over long periods of time, whereas the third
component, factory utilization, changes the mostly over shorter periods. This points us two
words and better understanding of the difference between a short run and the long-run changes
The long-run: factor supply
The two main factors of production—labor and capital—account for most of the change in the
economy is factors supply, F.
The economy’s supply of labour can increase for two main reasons.
1. First population can increase and an increase in population can be caused in turn either by
greater immigration, an increase in birth rates, or decrease in mortality rates.
2. Increase in the fraction of population that chooses to seek employment. This fraction is called
the labour force participation rate.
Population growth and labour force participation rate tend to be gradual so no matter how the
economy’s supply of labour increases, the important point is that such changes are mostly long-
The economy’s supply of physical capital, machines, factories and warehouses—increase for one
reason. Firms that choose to purchase or build such investment goods today are accumulating
physical capital that will be used to produce output in the future. Therefore, today’s flow of
investment expenditure adds to the economy’s stock of physical capital.
The difference is that investment is the flow that contributes to the stock of capital, but the
economy’s capital stock is so large compared with the annual flow of investment generate
almost imperceptible changes in the stock of capital.
Changes in the economy’s supply of labour and capital occur gradually, but over period of
many years their growth is considerable. As a result, changes in factors supply are important
for explaining long-run changes in output but relatively unimportant for explaining short-run
The long run: productivity:
The economy’s level of productivity (GDP/Fe) is a measure of the average amount of output that
is produced per unit in input.
The measure of productivity used in the equation is the concept of output