March 23, 2018 

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LONG-RUN AGGREGATE MARKET: A macroeconomic model relating the price level and real production under the assumption that ALL prices flexible. This is one of two aggregate market submodels used to analyze business cycles, aggregate production, unemployment, inflation, stabilization policies, and related macroeconomic phenomena. The other is the short-run aggregate market. The long-run aggregate market isolates the interaction between aggregate demand and long-run aggregate supply. The key assumption of this model is that ALL prices, especially resource prices, are flexible. The primary result of this model is that the economy achieves long-run equilibrium at full-employment real production.

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Lesson 15: Aggregate Market | Unit 4: Self Correction Page: 18 of 22

Topic: Inflationary Gap <=PAGE BACK | PAGE NEXT=>

The aggregate market can automatically reach long-run equilibrium by closing an inflationary gap.

Key points:

  • Short-run equilibrium is at the intersection of the AD and the SRAS (SRo) curves.
  • The initial short-run price level is Po, and real production is Qo.
  • Short-run equilibrium is to the right of the full employment production, Qf.
  • We have an inflationary gap.
  • As wages rise, production cost increases which decreases short-run aggregate supply.
  • The SRAS curves shift to reach the full employment level at the intersection of the LRAS and AD curves.

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The short-run aggregate supply curve, or SRAS curve, has similarities to, but differences from, the standard market supply curve. Both are positively sloped. Both relate price and quantity. However, the market supply curve is positively sloped due to the law of diminishing marginal returns and the short-run aggregate supply curve is positively-sloped due to inflexible prices, the pool of natural unemployment, and imbalances in real resource prices.

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