Short-run equilibrium and output gaps
Where the economy sits vs where it could be.
Short-run macroeconomic equilibrium. Where AD = SRAS. Determines:
- Real GDP (current output, Y).
- Price level (general price level).
Long-run macroeconomic equilibrium. Where AD = SRAS = LRAS at full employment (Y = Yf).
Output gaps.
Recessionary (deflationary) gap. Y < Yf. Equilibrium real GDP below potential.
- Cyclical unemployment.
- Downward pressure on prices and wages.
- Idle capacity.
Inflationary gap. Y > Yf. Equilibrium real GDP above potential (temporarily).
- Demand-pull inflation.
- Very low unemployment.
- Wages and input costs being bid up.
Keynesian vs neoclassical perspectives.
Neoclassical (Monetarist):
- Wages and prices are flexible — adjust to clear markets.
- Recession reduces wages and input costs → SRAS shifts RIGHT → economy returns to Yf.
- Government intervention is often counter-productive.
Keynesian:
- Wages are STICKY downward (workers resist nominal wage cuts; contracts).
- Recession can PERSIST as a long-lasting underperformance.
- Government should boost AD through fiscal/monetary policy.
- Famous: "In the long run, we are all dead" — short-run misery matters.
Keynesian AS shape (Keynesian L-shaped curve, also "modern Keynesian"):
- HORIZONTAL at low output (spare capacity → easy expansion without inflation).
- UPWARD slope near full employment.
- VERTICAL at Yf.
This shape captures the idea that AD increases boost output cheaply when there's slack, but only raise prices once near full employment.
- SR equilibrium AD = SRAS; LR adds LRAS.
- Recessionary gap: Y < Yf.
- Inflationary gap: Y > Yf.
- Neoclassical: self-correcting LR.
- Keynesian: sticky wages, intervention needed.