Equilibrium

Equilibrium November-26-08 9:04 AM

-An economy`s equilibrium price level and real output occur at the intersection of the AD and AS curves.

Inventory Changes - Inventory increase ○ At this price level - real output exceeds real expenditures - more is produced than is purchased in the economy ○ Businesses have an unintended increase in inventories - surplus - which represents a positive unplanned investment. As a result of this surplus, prices of individual decrease, pushing down the general price level. ○ Lower prices - cause businesses to decrease output (since real outputs and unemployment are inversely related, this causes a rise in the unemployment rate ○ This trend continues until equilibrium SURPLUS

Price Level 160

AS

B (EQUILIBRIUM)

AD SHORTAGE 700

Real GDP

- Inventory Decrease ○ Suppose price levels are below equilibrium levels-expenditures exceed production ○ Expenditures exceed production-creates a shortage ○ This leads to an unintended decrease in inventories - negative unplanned investment ○ Particular products are in short supply, prices rise ○ Buyers response - decrease spending ○ Higher price level causes businesses to raise real output- unemployment falls Role of Unplanned Investments Unplanned investment is - +ve- when price level is above equilibrium value - -ve - when price level is blow equilibrium value

Unit 3 - Fiscal Policy Page 1