Short-run equilibrium is a fundamental concept in macroeconomics, particularly within the Aggregate Demand-Aggregate Supply (AD-AS) model. Understanding short-run equilibrium is essential for College Board AP students as it provides insights into how economies stabilize temporarily amidst fluctuations in aggregate demand and supply. This equilibrium helps in analyzing the effects of various economic policies and external shocks on national income and price levels.

Key Concepts

Definition of Short-run Equilibrium

Short-run equilibrium occurs in the AD-AS model when aggregate demand (AD) intersects with short-run aggregate supply (SRAS) at a particular price level and output. In this state, the economy is producing at a level where total demand equals total supply, and there is no inherent pressure for prices or output to change in the short run.

Aggregate Demand and Short-run Aggregate Supply

Aggregate Demand represents the total demand for goods and services in an economy at various price levels, depicted by the downward-sloping AD curve. Short-run Aggregate Supply, on the other hand, is the total production of goods and services by firms when some input prices are fixed, shown by the upward-sloping SRAS curve.

Equilibrium Price and Output

In short-run equilibrium, the intersection of AD and SRAS determines the equilibrium price level ($P^*$) and the equilibrium output ($Y^*$). Mathematically, this can be expressed as: $$AD = SRAS$$ At this point, planned expenditure equals actual output, and there is no unintended inventory buildup.

Shifts in Aggregate Demand

Several factors can shift the AD curve, including changes in consumer confidence, fiscal policy, monetary policy, and external factors like exchange rates. For instance, an increase in government spending shifts AD to the right, leading to a higher equilibrium price level and output in the short run.

Shifts in Short-run Aggregate Supply

The SRAS curve can shift due to changes in input prices, such as wages and raw materials, technology advancements, and supply shocks. An increase in input costs causes the SRAS curve to shift leftward, resulting in a higher price level but lower output in equilibrium.

Role of Expectations

Expectations about future economic conditions influence short-run equilibrium. If firms expect higher future prices, they may increase current production, shifting SRAS to the right. Conversely, pessimistic expectations can reduce current output, shifting SRAS to the left.

Short-run vs. Long-run Equilibrium

While short-run equilibrium focuses on temporary stabilization with fixed input prices, long-run equilibrium assumes flexible prices and wages, where the economy operates at its natural level of output ($Y_n$). In the long run, the economy tends to adjust towards this natural level, negating short-run deviations.

Impact of Fiscal and Monetary Policies

Fiscal policies, such as taxation and government spending, directly affect aggregate demand. Expansionary fiscal policy (increased spending or decreased taxes) shifts AD rightward, enhancing output and price levels temporarily. Monetary policies, including interest rate adjustments and open market operations, also shift AD by influencing investment and consumption.

Inflationary and Recessionary Gaps

An inflationary gap occurs when actual output exceeds potential output ($Y > Y_n$), leading to upward pressure on prices. Conversely, a recessionary gap happens when actual output falls below potential output ($Y < Y_n$), resulting in unemployment and downward pressure on prices.

Graphical Representation of Short-run Equilibrium

Graphically, short-run equilibrium is depicted where the AD curve intersects the SRAS curve. The equilibrium price level ($P^*$) and output ($Y^*$) are identified at this intersection. Shifts in either AD or SRAS result in a new equilibrium, illustrating the dynamic nature of the economy in the short run.

Examples of Short-run Equilibrium Adjustments

For example, consider an economy experiencing an economic boom. Increased consumer spending shifts AD rightward, elevating both price levels and output in the short run. However, this can lead to inflationary pressures. To restore equilibrium, monetary authorities might tighten the money supply, shifting AD back to its original position.

Mathematical Representation

The short-run equilibrium can also be analyzed using aggregate demand and supply functions. Suppose: $$AD = C + I + G + (X - M)$$ $$SRAS = P \cdot Y - w \cdot L$$ Setting $AD = SRAS$ allows solving for equilibrium price level and output.

Comparison Table

Aspect	Short-run Equilibrium	Long-run Equilibrium
Price Flexibility	Prices are sticky/fixed	Prices are flexible
Output Level	Can be above or below potential output	Equals natural level of output ($Y_n$)
Adjustment Mechanism	Temporary stabilization	Full adjustment to equilibrium
Role of Expectations	Influence short-term decisions	Aligned with long-term expectations
Policy Impact	Affects aggregate demand and supply temporarily	Policies influence the natural level of output

Summary and Key Takeaways

Short-run equilibrium occurs where AD intersects SRAS, determining price and output levels.
Various factors can shift AD and SRAS, influencing the economy's stability.
Understanding short-run equilibrium aids in analyzing economic policies and their temporary effects.
Distinguishing between short-run and long-run equilibrium is crucial for comprehensive macroeconomic analysis.

Examiner Tip

Tips

To master short-run equilibrium, remember the acronym ADSR: Aggregate Demand, Short-run Aggregate Supply, and their Relations. Practice sketching the AD and SRAS curves to visualize shifts clearly. Additionally, always tie policy changes to their impact on AD or SRAS—this connection is essential for AP exam questions. Utilize flashcards for key terms and formulas to reinforce your understanding and retention.

Did You Know

Did you know that during the 1970s, many economies experienced stagflation—a combination of stagnant growth and high inflation—due to shifts in short-run aggregate supply? This phenomenon challenged traditional economic theories and led to new policy approaches. Additionally, natural disasters and geopolitical events can cause sudden shifts in SRAS, demonstrating the model's real-world applicability in predicting economic responses to unforeseen shocks.

Common Mistakes

One common mistake students make is confusing short-run and long-run equilibrium, often expecting immediate adjustments in prices and output. For example, incorrectly assuming that input prices adjust instantly can lead to misunderstandings of SRAS shifts. Another error is misidentifying the direction of shifts; students might think an increase in government spending shifts SRAS instead of AD. Ensuring clarity between AD and SRAS influences is crucial for accurate analysis.

FAQ

What is short-run equilibrium in the AD-AS model?

Short-run equilibrium occurs where the aggregate demand curve intersects the short-run aggregate supply curve, determining the economy's price level and output in the short term.

How do shifts in aggregate demand affect short-run equilibrium?

Shifts in aggregate demand can increase or decrease the equilibrium price level and output. For instance, an increase in AD shifts the curve rightward, leading to higher prices and increased output in the short run.

What factors cause the short-run aggregate supply curve to shift?

Factors include changes in input prices, technological advancements, and supply shocks. An increase in input costs, for example, shifts SRAS leftward, resulting in higher prices and lower output.

How does short-run equilibrium differ from long-run equilibrium?

Short-run equilibrium involves temporary stabilization with fixed input prices, allowing output to deviate from its natural level. Long-run equilibrium assumes flexible prices and wages, with output aligning with the natural level of output ($Y_n$).

Can fiscal and monetary policies influence short-run equilibrium?

Yes, fiscal and monetary policies can shift aggregate demand or supply, thereby affecting short-run equilibrium. For example, expansionary fiscal policy increases AD, while contractionary monetary policy can decrease AD.

What is an inflationary gap?

An inflationary gap occurs when actual output exceeds potential output ($Y > Y_n$), leading to upward pressure on prices and potential overheating of the economy.

1. Economic Indicators and the Business Cycle

1.1 Limitations of GDP

1.1.1 Informal economies

1.1.2 What GDP measures

1.2 Unemployment

1.2.1 Types of unemployment

1.2.2 Natural rate of unemployment

1.2.3 Costs of unemployment

1.3 Inflation and Price Indices

1.3.1 CPI

1.3.2 PPI

1.3.3 Real vs. nominal values