Equilibrium Real GDP and the Price Level

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As discussed before, the equilibrium of price level and real GDP is determined by short-run aggregate supply and aggregate demand. After understand the change in aggregate demand curve, we can say that change is any component in the autonomous expenditure especially investment changes the aggregate demand along with the shift in the curve of the same where the magnitude of curve shift is dependent on the multiplier. But what happens in long run and short run? Let’s discuss the same:

What will happen in short run?

The figure shows the economy of the country. We can see that at an initial stage that the curve of the aggregate expenditure is AE0 and the equilibrium is served at 13 trillion dollars on the point at A. In the second part, we can measure that the curve of aggregate demand is AD0 and SAS is the resultant curve of aggregate short run supply. Equilibrium is served at point A in the second part where the intersection of curve of aggregate demand curveand curve of short run aggregate supply. The level of price is constant at 110, and 13 trillion dollars is served as the real GDP.

Let’s consider a situation where an investment is increased by one trillion dollars. Under this case, the curve of aggregate expenditure shifts up to AE1 and the equilibrium is increased to 15 trillion dollars which is at B point. In the second part, the curve of aggregate demand moves to the rightward direction to AD1 with the movement of 2 trillion dollars. We know that the magnitude of the aggregate demand curve can be determined by multiplier. But in this new curve of aggregate demand, the price level is not constant. Here we can notice that when the price level rises, the curve of the aggregate expenditure is shifted downwards.

We can notice the situation of equilibrium of short run when AE2 serves the curve of the aggregate expenditure which means that the new curve of aggregate demand will intersect the curve of shirt run aggregate supply at another point C in both the parts. The real GDP is thus changes to 14.3 trillion dollars and the level of the price is served at 123. Therefore, we can say that the when the slope of the curve of short run aggregate supply is steeper, it realizes a larger increase in the level of the price and also a smaller effect of the multiplier on the real GDP.

What will happen in long run: A hike in Aggregate Demand in Long Run?

We can notice the effects of long run I the next figure which illustrates increasing aggregate demand. We can say that in long run, the real GDP is similar to the potential GDP in future where the value of the full employment GDP is served as 13 trillion dollars where Las serves as the curve of long run aggregate supply. At an initial stage, the economy will be served at A point in both the parts. When the investment in increased to one trillion dollars, the curve of the aggregate expenditure will move to AE1 and the curve of the aggregate demand will move to AD1. When price level is constant, the equilibrium or the economy will be serving at point B and the increase of 15 trillion dollars will be realized on the real GDP. When we exceed the real GDP to the potential GDP, the full employment will be considered lesser than labor force and the increase in the rate of money wage will realized in long run under the presence of shortage of labor. When money wage rate is higher, the firm’s cost is also increased which move the curve of shirt will run aggregate supply from SAS to SAS1. As the price level will rise, the value of real GDP will start decreasing which means there will be movement along AD1 where AE curve will move downwards from AE2 to AE0. In the long run, multiplier is turn zero, when money wage rate andprice level increases by the same level of percent resulting into economy serves at point A where real GDP and potential GDP are equal.


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