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Aggregate Demand and Aggregate Supply

Short-Run Macroeconomic Equilibrium

Short-run macroeconomic equilibrium is achieved when aggregate demand and aggregate supply are equal in the short term.

In the short run, macroeconomic equilibrium exists at the point where aggregate demand is equal to aggregate supply. In graphical form, this is the point where the aggregate demand curve meets (or intersects) the short-run aggregate supply curve. In real economies, this state is not achieved or maintained for very long. Numerous factors cause aggregate supply and aggregate demand to shift to a new short-run equilibrium.

A shift in the aggregate demand curve to the left (from a decrease in investment, for example) initially leads to excess output, where the quantity all firms in the aggregate are willing to supply at the current price level is greater than aggregate demand. This has a number of consequences on the wider economy. An excess of goods causes price levels to fall. This, in turn, reduces output. The result is that output eventually reaches an equilibrium level with a lower price level. On the other hand, an increase in aggregate demand (from an increase in exports, for example) leads to an initial shortage of goods, as aggregate demand is greater than the quantity of goods and services all firms in the aggregate are willing to supply at the current price level. A shortage of output (relative to aggregate demand at current price levels) eventually causes an increase in both the equilibrium output and price levels.
Equilibrium exists where aggregate demand (AD1) meets short-run aggregate supply (SRAS). Shifts in AD affect the equilibrium. Shifting left (AD3 lowers price level and output; shifting right (AD2 increases price level and output.
Increases in short-run aggregate supply can be caused by hiring more employees and increasing output. Another example where aggregate supply increases at times is the lowering of wages and the subsequent hiring of new employees. Short-run aggregate supply can decrease when the price of products or inputs needed for manufacturing increases, making the final product more expensive. Unplanned short-run decreases in aggregate supply, meanwhile, limit the supply of goods and services. Prices rise accordingly, and the aggregate supply curve shifts to the left. This results in a new equilibrium with a higher price level and lower output. Finally, unplanned short-run increases in aggregate supply shift the aggregate supply curve to the right, which results in a new equilibrium with a lower price level and higher output.