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The demand for real money balances mpd lr because

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Unformatted text preview: rt run, the AS curve depends on the time horizon: the long run aggregate supply curve LRAS and the short run aggregate supply curve SRAS. Long run: In the classical model, the amount of output is fixed by the fixed amounts of labour and capital and on the available technology. According to the classical model, output does not depend on the price level, so we draw a vertical aggregate supply curve. The intersection of AD and the LRAS determines the price level in the long run. A shift in aggregate demand only affect prices, not output. The long run level of output, Y¯,, is called the full- employment or natural level of output. It is the level of ougput at which the economy’s resources are fully employed, or, more realistically, at which employment is at its natural rate. Short run: in the short run, we assume the extreme example where prices are completely stuck at predetermined levels. This results in a horizontal SRAS curve. The short run equilibrium of the economy is the intersection of the aggregate demand curve and the horizontal SRAS curve. A shift in aggregate demand affects output only, not prices, the opposite of the long run scenario. Thus, a fall in AD reduces output in the short run because prices do not adjust instantly. Firms are stuck with prices that are too high so with reduced demand and high prices, firms sell less and lay off workers and reduce production. This creates a recession. Page 28 of 52 Jessica Gahtan Prof: Mokhles Hossain Macroeconomics ECON2000 Fall 2013 Over long periods of time, prices are flexible, the aggregate supply curve is vertical, and changes in aggregate demand affect the price level but not output. Over short periods of time, prices are sticky, the aggregate supply curve is flat, and changes in aggregate demand do affect the economy’s output of goods and services. Moving from the short run to the long run: assume the economy is in long run equilibrium, with SRAS=AD=LRAS. A decrease in the money supply shift AD leftward, resulting in decreased output with a constant price level. Over time, the economy moves along the AD curve back to the intersection with the LRAS curve, making the long- run result the same amount of output with lower prices. Economists call exogeno...
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