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Econ 203 MIDTERM 2 (Study Guide)
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- Econ 203
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ECON 203 Chapter 9-13 Introduction toMacroeconomics study guide exam update
(Concordia University)
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ECON 203 Chapter 9-13 Introduction to Macroeconomics
study guide exam update (Concordia University)
Downloaded by: emilkhatch | emilkhatch@gmail.com Want to earn $1.236
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CHAPTER 9
FROM THE SHORT RUN TO THE LONG RUN: THE
ADJUSTMENT OF FACTOR PRICES
9.1 THREE MACROECONOMIC STATES
In the last three chapters, we considered the economy in the short run. In the next
chapter we will examine the economy in the long run. In this chapter we explore the
details of the crucial adjustment process that takes the economy from its short-run
equilibrium to its long-run state.
*REMINDER*
An economy’s level of potential GDP is the amount of output that can be produced
when all land, labour, and capital are fully employed. In the short run, real GDP may be
above or below as a result of various aggregate demand or aggregate supply shocks.
Exogenous: external factor
Endogenous: internal factor
The Short Run The Adjustment The Long Run
Process
Key
Assumptions Factor prices Factor prices are Factor prices are
areexogenous. flexible/endogenou fully
s adjusted/endogenou
Technology and . s
factor supplies (and .
thus Y*) are Technology and
constant/exogenous. factor supplies (and Technology and
thus Y*) are factor supplies
constant/exogenou (andthus Y*) are
s. changing.
What Happens Real GDP (Y) is Factor prices Potential (Y*) GDP
determined by adjustto output usually growsover
aggregate gaps; realGDP the long run.
demandand eventually returns
aggregate to Y*.
supply.
Why We Study To show the effects To see how output To understand
This State of AD and AS shock gaps cause factor the nature of
s on real GDP. prices to change long-run
and economic
why real GDP tends growth.
to return to Y*.
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9.2 THE ADJUSTMENT PROCESS
I. POTENTIAL OUTPUT AND THE OUTPUT GAP
*REMINDER*
Potential output is the total output that can be produced when all productive
resources— land, labour, and capital—are fully employed. When a nation’s actual
output diverges from its potential output, the difference is called the output gap.
Figure 9-1 – Output Gaps in the Short Run
The output gap is the difference between actual GDP and potential GDP, Y – Y*.
Potential output is shown by the vertical line at Y*. A recessionary gap, shown in part (i),
occurs when actual output is less than potential GDP. An inflationary gap, shown in part
(ii), occurs when actual output is greater than potential GDP.
II. FACTOR PRICES AND THE OUTPUT GAP
We make two key assumptions in our macro model regarding factor prices and the
outputgap:
• First, when real GDP is above potential output, there will be pressure on
factorprices to rise because of a higher-than-normal demand for factor inputs.
• Second, when real GDP is below potential output, there will be pressure on
factorprices to fall because of a lower-than-normal demand for factor inputs.
Output Above Potential, Y > Y*
The boom that is associated with an inflationary gap generates an excess demand
forfactors that tends to cause wages (and other factor prices) to rise.
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