The extended name for this model is the aggregate product market, to emphasize that it reflects the exchange of gross domestic product in the macroeconomic product markets. However, the two other basic macroeconomic markets--financial markets and resource markets--play key roles behind the scenes and close to the surface of the aggregate market.

The Basic Graphical Model

The Aggregate Market

The analytical value of this model results from identifying the equilibrium price level and real production. Then perhaps more informative, the model is used analyze shifts of these three curves and how the shifts affect the equilibrium price level and real production. In so doing implications about unemployment, inflation, income, and other macroeconomic activity can be obtained.

Inspired by the Market

• One key difference is the measurement units. The "price" in the aggregate market is actually the price level, usually measured by the GDP price deflator, and the "quantity" is real production, usually measured by real gross domestic product (real GDP).


• Another key difference is the supply-side of the model. The supply-side of the aggregate market is divided into short-run aggregate supply and long-run aggregate supply. The difference between these two is based on price flexibility, or the time required for prices to adjust to equilibrium levels. The long-run aggregate supply presumes that ALL prices are flexible, while the short-run aggregate supply presumes that some prices, especially resource prices, are inflexible.

Going Long and Short

The Long-Run Aggregate Market
The Short-Run Aggregate Market

• Long-Run Aggregate Market: The long-run aggregate market, presented in the top panel of the exhibit to the right, 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. This gives rise to the vertical long-run aggregate supply curve. The primary result of this model is that the economy achieves long-run equilibrium at full-employment real production.


• Short-Run Aggregate Market: The short-run aggregate market, presented in the bottom panel of the exhibit to the right, isolates the interaction between aggregate demand and short-run aggregate supply. The key assumption of this model is that some prices, especially resource prices, are inflexible. This generates the positively-sloped short-run aggregate supply curve. The primary result of this model is that the economy can achieve short-run equilibrium at real production levels that are greater or less than full employment.

In particular, an inflationary gap results if short-run equilibrium production exceeds full employment and a recessionary gap occurs if production falls short of full employment. These output gaps not only illustrate the essence of business-cycle instability, but also suggest the role stabilization policies can play in achieving full employment.

Three Markets In One

• Financial markets provide the liquidity (money and loans) that buyers use to purchase the production.


• Resource markets provide the inputs (labor, capital, land, and entrepreneurship) that producers need to supply the production.

• Long-run equilibrium is based on equilibrium in ALL three aggregate markets, product, financial, and resource.


• Short-run equilibrium, in contrast, is based on equilibrium in the product and financial markets, but disequilibrium in the resource markets.