Macroeconomics
Thisinflationarygapismostlikelyduetoan increase in AD that shifts its curve to the right(e.g.,increaseinnetexports).Thisgap persistsintheshortrunduetoimbalances in real resource prices that allow overemployment and prevent equilibrium in the labor and resource market.
However, in the long run, wages and resources prices adjust by increasing, which allows employment to return to its natural, full-employment level (NRU). Higher wages raise production costs. As a result, SRASdecreases,shiftingitscurve to the left until it intersects withboththe AD and LRAS curves at point B where the inflationary gap is closed and the long-run equilibrium is achieved . G. Long-Run Self-Adjustments in the AD-AS Model Keynesians believe that the economystartsoperatingbelowthepotentialoutputintheshortrun,and onlyreachesthepotentialoutputinthelongrun.Thiscanbeachieved throughgovernmenteconomic policies that boost AD (e.g., expansionary fscalpolicy). However,accordingtoClassicaleconomists, theeconomyisinherentlyatthepotentialGDPleveland prices adjust on their own without any government intervention .Theybelievethatthisisachieved becauseofthe long-runself-adjustmentmechanism .Thismechanismreflectstheideathat,overtime, the economy tends to return to full employment, which is its naturalequilibrium.Inotherwords,the economy “goes back to normal” on its own after a shock. At its essence, the self-correcting mechanism revolves around the adjustment of prices . When a shock occurs, prices will adapt to steer the economyback to its long-term equilibrium . Let’s examine how the long-run self-adjustment mechanism works to restore long-run equilibrium following a demand shock, specifcally a positive one.
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