Equilibrium Short-Run Aggregate Market

This graph to the right can be used to illustrate equilibrium in the short-run aggregate market. First, to set up the graph, the vertical axis measures the price level (GDP price deflator) and the horizontal axis measures real production (real GDP). The negatively-sloped curve, labeled AD, is the aggregate demand curve and the positively-sloped curve, labeled SRAS, is the short-run aggregate supply curve. Short-run equilibrium is the price level and real production obtained at the intersection of the AD and SRAS curves.

Because the SRAS curve is positively-sloped, short-run equilibrium can occur at ANY level of real production. It need NOT be full employment. To demonstrate that short-run equilibrium can occur at different levels of real production should aggregate demand change, click the [AD Increase] and [AD Decrease] buttons. An increase in aggregate demand leads to a higher price level AND an increase in real production. A decrease in aggregate demand leads to a lower price level AND a decrease in real production.

Short-run aggregate market equilibrium means the economy has no wide-spread shortages or surpluses in the product markets. However, this does not necessarily mean that ALL product markets are in equilibrium. A complex economy, like that in the United States, is bound to have shortages in some product markets and surpluses in others in short-run equilibrium. As such, prices in some markets rise, while those in other markets fall.

These sorts of imbalances in specific markets reflect the ongoing reallocation of resources at the microeconomic level. What is required for aggregate market equilibrium at the macroeconomic level is that the microeconomic shortages and surpluses cancel out, that rising prices cancel falling prices, that the price level and real production do not change.

By far the most important implication of short-run equilibrium is unemployment. Short-run price rigidity means that resource markets are out of balance, meaning either shortages or surpluses. In particular, there is some degree of cyclical unemployment or overemployment. This is why the SRAS curve is positively-sloped. At higher or lower price levels, real production can exceed or fall short of full-employment real production, resulting in overemployment or cyclical unemployment. And because short-run equilibrium can occur at ANY point on the SRAS curve, it need not be full employment. Another way of stating this is that the economy produces ANYTHING BUT full-employment real production in the short run.