2.4.3 Equilibrium levels of Real National Output

This study note for Edexcel economics covers Equilibrium levels of Real National Output

a) The Concept of Equilibrium Real National Output

Equilibrium Real National Output:

• The equilibrium real national output is the level of GDP where aggregate demand (AD) equals aggregate supply (AS).
• At this equilibrium, there is no tendency for the economy to change its output level; all produced goods and services are sold, and there is neither excess supply nor excess demand.

Key Characteristics:

• Price Stability: Prices are stable, with no inflationary or deflationary pressures.
• Full Employment: The economy operates at full employment, meaning all available resources are utilized efficiently.
• Sustainable Output: The output level is sustainable in the long run without causing imbalances.

Real-World Example:

• In a hypothetical economy, if AD equals AS at a GDP level of $2 trillion, this is the equilibrium output. Any deviation from this point would prompt adjustments in prices or output to restore equilibrium.

b) How Shifts in AD or AS Cause Changes in the Equilibrium Price Level and Real National Output

AD/AS Model:

• The Aggregate Demand (AD) curve represents the total quantity of goods and services demanded at different price levels.
• The Aggregate Supply (AS) curve represents the total quantity of goods and services that producers are willing and able to supply at different price levels.
• The intersection of the AD and AS curves determines the equilibrium price level and real national output.

Shifts in AD:

• Increase in AD:
  • Caused by factors such as higher consumer confidence, increased government spending, or tax cuts.
  • Results in a rightward shift of the AD curve.
  • Leads to a higher price level (inflation) and an increase in real national output.
• Decrease in AD:
  • Caused by factors such as reduced consumer spending, lower government expenditure, or higher taxes.
  • Results in a leftward shift of the AD curve.
  • Leads to a lower price level (deflation) and a decrease in real national output.

Shifts in AS:

• Increase in AS:
  • Caused by factors such as technological advancements, reduction in production costs, or improvements in labor productivity.
  • Results in a rightward shift of the AS curve.
  • Leads to a lower price level and an increase in real national output.
• Decrease in AS:
  • Caused by factors such as natural disasters, increased production costs, or labor strikes.
  • Results in a leftward shift of the AS curve.
  • Leads to a higher price level and a decrease in real national output.

Real-World Examples:

• Increase in AD: During the COVID-19 pandemic, various governments increased spending and provided stimulus checks, shifting AD to the right.
• Decrease in AS: The 1970s oil crisis saw a sharp increase in oil prices, shifting the AS curve to the left, causing stagflation (higher prices and lower output).

Glossary

• Aggregate Demand (AD): The total demand for goods and services within an economy at a given overall price level and in a given time period.
• Aggregate Supply (AS): The total supply of goods and services that firms in an economy plan on selling during a specific time period.
• Full Employment: A situation in which all available labor resources are being used in the most economically efficient way.
• Stagflation: A situation of slow economic growth and high unemployment (stagnation) accompanied by rising prices (inflation).

Key Economists

• John Maynard Keynes: Emphasized the role of aggregate demand in determining economic output and employment.
• Milton Friedman: Advocated for the importance of monetary policy and its impact on price levels and output.
• Robert Solow: Contributed to the understanding of long-term economic growth and the role of technological progress in shifting the aggregate supply curve.

Possible Essay-Style Questions

1. Discuss the factors that can lead to shifts in the aggregate demand curve and their potential impacts on the equilibrium price level and real national output.
2. Analyze the effects of a significant increase in production costs on the aggregate supply curve and the resulting changes in the economy's equilibrium.
3. Evaluate the role of government intervention in managing economic stability through shifts in aggregate demand and aggregate supply.