OCR Economics A-level

Transcription

1 OCR Economics A-level Macroeconomics Topic 2: Aggregate Demand and Aggregate Supply 2.5 Macroeconomic equilibrium Notes

2 The economy reaches a state of equilibrium where AD = AS. How both demand-side and supply-side shocks affect the macro economy At a price above equilibrium, there will be excess supply. At a price below equilibrium, there will be excess aggregate demand, in the short run. Shift in AS:

3 If the economy becomes more productive, or if there is an increase in efficiency, supply will shift to the right. This lowers the average price level (Pe to P1) and increases national output (Ye to Y1). If AS shifts inwards, price increases and national output decreases. Shift in AD: If firms have less confidence or there is a recession, AD might shift inwards. This causes the price level to fall from Pe to P1, and national output to fall from Ye to Y1. If AD increases, the price level and level of national output both increase.

4 In the short run, equilibrium might be less than the level needed to reach the level of GDP at full employment. This occurs when there is inefficient AD in the economy, and a negative output gap is created. This means there is unemployment in the economy. In the short run, the equilibrium position might be above the level needed to reach the level of GDP at full employment. This occurs when there is excess AD in the economy, and a positive output gap is created.

5 Different theoretical approaches to how the macro economy functions Keynesian economics is a view that believes AD (spending) influences economic output in the short run. Keynesians also believe that the private sector sometimes leads to inefficiency, so the public sector has to intervene in order to stabilise the business cycle. This refers to monetary policy and fiscal policy in particular. Keynesians prefer mixed economies, where the private sector is dominant, but the government intervenes during recessions. The Great Depression initiated in 1929, and by 1933 real GDP had fallen by 30% and the unemployment rate increased to 25%. In the 75 years prior to this, economic declines lasted about 2 years; the Great Depression lasted for over a decade. Keynes shifted macroeconomic thought from a focus on AS to AD. Keynesian economists emphasise the use of demand-side policies, fiscal and monetary, to close gaps between actual and potential output. The 2008 financial crisis caused an increase in popularity of Keynesian beliefs. Keynesians believe that as long as firms have confidence about the future, they will invest. Investment is independent of the price level or interest rates. Monetarism emphasises government control over the money supply. This view believes that changes in the money supply influences national output in the short run, and influences the price level in the long run. Rather than how confident firms feel, monetarists believe that interest rates have a greater influence over investment decisions. Monetarists believe that inflation is caused by excessive quantities of money flowing in the system. If production increases at a slower rate to the money supply, monetarists argue that there will be inflation. The money supply increases when more money is printed or there are several loans and credit. Keynesian view of long run aggregate supply

6 The Keynesian view suggests that the price level in the economy is fixed until resources are fully employed. The horizontal section shows the output and price level when resources are not fully employed; there is spare capacity in the economy. The vertical section is when resources are fully employed. Over the spare capacity section, output can be increased (AD1 to AD2) without affecting the price level (stays at P1). In other words, output changes are not inflationary. Once resources are fully employed, an increase in output (AD3 to AD4) will be inflationary (price level increases from P2 to P3).

7 Friedrich Hayek is associated with the Austrians school of thought. The Austrian school generally criticises socialism and Marxist analyses of income and wealth distribution. It supports the free market and capitalist economic systems. They believe that the free market has the most efficient distribution of economic resources. Moreover, the Austrian school believes that economic models cannot be derived when consumer behaviour is assumed. They believe that consumers are individuals. The Austrian school believes that monopoly power is efficient and should be encouraged.