TRADE FOREIGN UNIVERSI

I. Aggregate Demand and Aggregate Supply

1. Aggregate Supply (AS)
Definition: Aggregate supply is the level of domestic output that firms are willing and
able to produce and supply at a given price level, with all other factors held constant.
Because the impact of the price level on the aggregate supply curve is very different in the
short run and the long run, we will use two aggregate supply curves: the short-run aggregate
supply curve (SRAS) and the long-run aggregate supply curve (LRAS).

2.1 Long-Run Aggregate Supply Curve (LRAS)

- The long-run aggregate supply curve is a set of all points that represent the aggregate
supply of an economy at different price levels in the long run.

Why is the long-run aggregate supply curve vertical?

 Potential GDP is the level of GDP that is achieved when the economy is at full
employment (full employment) - the unemployment rate is at the natural rate, machines
are being used at average capacity.
 In the long run, potential GDP only depends on the productive capacity of the economy,
and this capacity is not dependent on P → LRAS is vertical.

Shifts of LRAS

 Shifts due to labor (L)

 Shifts due to capital/investment (K)
 Shifts due to natural resources (R)
 Shifts due to technological knowledge (T)

2.2 Short-Run Aggregate Supply Curve (SRAS)

- The short-run aggregate supply curve is a set of all points that represent the aggregate
supply of an economy at different price levels in the short run.
Features of SRAS
 - SRAS is relaxed when actual output is below the level of Y. Reason: at this time the
economy still has many unused resources, so a small change in P can make Y increase a lot.*
- SRAS is steep when actual output is higher than the level of Y. Reason: at this time the
economy has very few unused resources.*

Why is the short-run aggregate supply curve sloping up?

 The theory of mistaken perception

 The theory of sticky wages
 The theory of sticky prices
 Vertical movement and shift of SRAS
 Vertical movement: when the general price level changes, all other factors remain
constant.
 Shift of SRAS

The 4 factors that cause the shift of the LRAS curve also cause the shift of the SRAS
curve, in addition to the following 3 factors:

 Change in expected prices in the future

 Changes in the prices of important fuels
 Changes in government tax rates

II. Macroeconomic equilibrium in the short run and the long run

1. Determining the equilibrium output and price

Equilibrium in the short run
 - In the short run, the economy is in equilibrium at the intersection of the AD curve with the
SRAS curve.

 At a price of P1 < P0, aggregate demand exceeds aggregate supply, P increases to P0.
 At a price of P2 > P0, aggregate supply exceeds aggregate demand, P decreases to P0.

How will the output of the economy change in the short run if:

- Households and firms are optimistic about the economy in the future: AD shifts to the
right, Y increases.
- The government reduces spending: AD shifts to the left, Y decreases.
- The government increases taxes: AD shifts to the left, Y decreases.
- Interest rates fall: AD shifts to the right, Y increases.
- The exchange rate falls (domestic currency appreciates): AD shifts to the right, Y
increases.
- A new oil field is discovered: SRAS shifts to the right, Y increases.
- The number of immigrants increases sharply: SRAS shifts to the right, Y increases.
- Firms and households expect the price level to rise by half: SRAS shifts to the right, Y
increases.
- Crude oil prices double: SRAS shifts to the left, Y decreases.

Equilibrium in the long run

- In the long run, the economy is in equilibrium at the intersection of the AD curve and the
SRAS curve, which lies on the LRAS.
- In reality, in the short run, the intersection of the AD curve and the SRAS curve may not
always lie on the LRAS. When this happens, it is called short-term economic fluctuations.
-The following cases may occur:
 Causes of Economic Fluctuations
1. Economic fluctuations in the long run and short run . If (AD) is held constant after
firms increase production costs
- Initial Impact of Increased Production Costs in Short run:
When firms experience an increase in production costs, it typically leads to a shift in the
aggregate supply (AS) curve to the left. This is because firms are willing and able to supply
less output at any given price level when their costs are higher. As a result, the price level
tends to rise, and real GDP may decrease.
- Impact of Constant AD in the Long Run :
If AD is held constant, then the shift in the AS curve to the left will cause the price level to
rise and real GDP to decrease. However, the economy will eventually return to its natural
rate of output, which is the level of output at which prices are equal to their long-run
equilibrium levels. This is because the shift in the AS curve will cause the price level to rise,
which will trigger a response from the central bank.

2. Economic Fluctuations in long run and short run. If policymakers shift AD to right after
firms increase production costs
Shifting aggregate demand (AD) to the right after firms increase production costs can
have a mixed impact on economic fluctuations in the long run. While it may temporarily
offset the negative effects of higher production costs, it can also lead to inflationary pressures
if not managed carefully.
- Initial Impact of Increased Production Costs
When firms experience an increase in production costs, it typically leads to a shift in the
aggregate supply (AS) curve to the left. This is because firms are willing and able to supply
less output at any given price level when their costs are higher. As a result, the price level
tends to rise, and real GDP may decrease. This can lead to economic stagnation or even
recession, depending on the severity of the cost increase and the overall economic conditions.
- Shifting AD to the Right to Counteract Cost Increases
In response to the negative impact of higher production costs, policymakers may consider
shifting AD to the right to stimulate economic activity and offset the decline in real GDP.
This can be done through various measures such as tax cuts, increased government spending,
or lower interest rates.
- Impact of AD Shift on Economic Fluctuations in the Long Run
In the long run, shifting AD to the right can have several economic consequences:
Increased Real GDP: By increasing overall demand, AD shifts can stimulate production and
lead to an increase in real GDP. This can help to offset the decline in real GDP caused by the
shift in AS due to higher production costs.
Employment Growth: As businesses expand production to meet increased demand, they may
hire more workers, leading to employment growth. This can help to reduce unemployment
and improve overall economic well-being.
Price Level Stability: While the initial AD shift may lead to a temporary rise in prices, the
economy's self-adjusting mechanisms tend to moderate price increases in the long run. Over
time, prices may stabilize or even decline as production capacity expands.

→ An Adverse Shift in Aggregate Supply :

 The chart shows an adverse shift in the aggregate supply (AS) curve from AS1 to AS2.
This means that at any given price level, firms are willing and able to supply less output.
This can be due to a number of factors, such as an increase in the price of inputs, a
natural disaster, or a labor strike.

 The shift to the left in the AS curve causes the price level to rise from P1 to P2 and the
quantity of output to fall from Y1 to Y2. This is because, at the original price level (P1),
there is now an excess demand for goods and services. Firms are willing and able to
supply less output at P1, while consumers and businesses are still willing and able to
demand the same amount of output. This excess demand drives up prices until they reach
the new equilibrium level (P2).

 The adverse shift in the AS curve has a number of negative consequences for the
economy. It leads to higher prices, lower output, and unemployment. This can lead to a
recession, which is a period of sustained economic decline.