Equilibrium Levels Of Real National Output

Question 1

When does real National output equilibrium occur?

Answer 1

Real national output equilibrium occurs where aggregate demand intersects with aggregate supply

Question 2

Describe a diagram, showing classical short run equilibrium resulting an equilibrium price

Answer 2

According to classical theory, this economy is in short run equilibrium at AP1Y1
Any changes to the components of AD will cause the AD curve to shift left or right creating a new short-run equilibrium
Any changes to the determinants of SRAS will shift the SRAS curve left or right creating a new short-run equilibrium

Question 3

What do classical and Keynesian economist believe about long run equilibrium of real national output

Answer 3

Classical economists believe that the economy will always return to its full potential level of output and all that will change in the long-run, is the average price level
Keynesian economists believe that the economy can be in long-run equilibrium at any level of output

Question 4

Describe a diagram that shows classical view of longer equilibrium

Answer 4

The LRAS curve demonstrates the maximum possible output of an economy using all of its scarce resources
The SRAS intersects with AD at the LRAS curve
This economy is producing at the full employment level of output (YFE)
The average price level at YFE is AP1

Question 5

Describe a diagram that shows the Keynesian and view of long run equilibrium

Answer 5

The vertical portion of the LRAS curve corresponds to the classical view of LRAS
The Keynesian view believes there is a maximum level of possible output
The LRAS curve becomes elastic at a certain price level as prices cannot fall further
Possibly due to minimum wage laws, the existence of trade unions, or long-term employment contracts preventing wage decreases
Real output national equilibrium can occur at any level of output
In this case equilibrium is at the intersection of LRAS and AD (AP1Y1)

Question 6

Describe a classical presentation of an increase in aggregate demand

Answer 6

The initial equilibrium level of output was at AP1Y1
An increase in one of the components of AD (e.g. consumption) causes the AD to increase AD1→AD2
Average prices in the economy rise to AP2 and the real level of output increases to Y2
The new short-run equilibrium is at AP2Y2

Question 7

Describe an increase in short run aggregate supply in a classical representation.

Answer 7

The initial equilibrium level of output was at AP1Y1
This equilibrium represents a recessionary or negative output gap equal to Y1YFE
An increase in one of the determinants of SRAS (e.g. productivity) causes the SRAS to increase SRAS1→SRAS2
Average prices in the economy fall to AP2 and the real level of output increases to Y2
The new short-run equilibrium is at AP2Y2
There is still a negative output gap but it is smaller (Y2YFE)

Question 8

Describe a keynesian view of changes to aggregate demand

Answer 8

The economy is initially in equilibrium at the intersection of AD1 and LRAS
The price level is AP1 and the output is at Y1
An increase in any component of AD (e.g. government spending) causes AD to shift from AD1→AD2
As this increase occurs close to the full employment level of output, there is a large increase in the average price level (AP1→AP2), but a relatively small increase in real output (Y1→Y2)

A decrease in any component of AD (e.g. net exports) causes AD to decrease from AD1→AD3
As this decrease occurs close to the elastic portion of the LRAS curve, there is a relatively larger decrease in the real output (Y1→Y3) than the decrease in the average price level (AP1→AP3)

If a further decrease in AD were to take place from AD3→AD4, there would be virtually no impact on the average price level, but the real output would fall from Y3→Y4

Question 9

Describe a diagram showing the classical view of an increase in the long run, aggregate supply of an economy

Answer 9

The initial potential output of this economy is seen at YFE
The economy is in equilibrium at AP1YFE

A change to the education level in the economy can increase the quality of labour and shift the LRAS to the right from LRAS1→LRAS2
There is now an increased level of possible output in the economy YFE1

The extra supply in the economy allows prices to fall and output to increase resulting in a new equilibrium at AP2YFE1

Question 10

Describe a diagram, showing the Keynesian view of an increase in the long run aggregate supply of an economy

Answer 10

The initial potential output of this economy is seen at YFE
The economy is in equilibrium at the intersection of AD1 and LRAS (AP1YFE)
A change to the immigration policy can increase the quantity of labour and shift the LRAS to the right from LRAS1→LRAS2
There is now an increased level of possible output in the economy YFE1
AD is in the vertical portion of the LRAS curve so output will increase (YFE→YFE1) and average prices will fall (AP1→AP3)

If the starting point of this economy had been the equilibrium at AD2Y2, then according to Keynesian thinking, an increase in LRAS would not impact the economy as it is stuck in a depression & requires AD to increase in order to change national output