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Main content
Current time:0:00Total duration:4:44
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Video transcript

what we have depicted here is an economy in long run equilibrium notice the point at which the aggregate demand curve and the short-run aggregate supply curve intersect that specifies an equilibrium price level P L sub 1 and an equilibrium level of output this equilibrium level of output Y sub 1 but notice that point of intersection it also intersects the long-run aggregate supply curve and so that is also our full employment output and just a reminder full employment output does not mean that everyone in the economy is employed it means that this is the level of employment that is sustainable the level of full employment if for some reason the unemployment rate were to get lower than that that that would be an unsustainable situation for this economy but what we really care about in this video is what happens if our aggregate demand curve shifts in the short run and in the long run so let's just imagine there's all sorts of positive news and aggregate demand shifts up so let's imagine so let me just shift our aggregate demand curve so it shifts like that so all of a sudden everyone has become more optimistic and at a given price level they just want to demand more output well what's going to happen in this universe well in this universe we have a new short-run equilibrium so we are now right over there let's call this let's call this price level 2 and then this is output level 2 so y sub 2 here and so what happened well in the short run we see that prices are as prices are going to go up the suppliers of the output are gonna say hey hey all these people want my output now I'm gonna charge more for it and I'm also going to increase output it's like hey there's a bonanza going on people are not only not only demand anymore but they're willing to pay for it more and so our output actually goes beyond our full employment output and so you can imagine maybe unemployment goes below the sustainable rate all sorts of people instead of going to school they're getting a job or whatever else they're coming out of retirement to work because there's just a bonanza going on but what's gonna happen in the long run well in the long run people who are working and could say gee you know my firm is having this bonanza at when my employment contract comes due I'm gonna ask for a raise and so as as labor prices go up what's going to happen to the short-run aggregate supply curve yes it is going to shift up as well and so let's make it shift well up as well B we're going to demand more and more and more and more and more and more money all the way to the point that we get to our sustainable level of output again and so what really happened is at first we had this price inflation and output increased beyond a sustainable level and then people say hey no no I want you know I want more for my time and so as wages went up then prices went up even further and so we get back to and if price is going up even further then even with the shifted aggregate demand curve people say well I might not want that much of it anymore and then we shift back to this point right over here and so now if this was aggregate demand - after everyone got all optimistic we will call this short-run aggregate supply - and our equilibrium price now is a good bit higher price level 3 but we are back to our full employment output so we could call this y sub 3 which is the same thing as Y sub 1 which is equal to our full employment output and what you have just seen this is known as the long-run self adjustment mechanism it's an argument that economists will sometimes make using this simplified model to say hey if you're in a situation that's either above your full employment output or below your full employment output it's ok it will in the long run self adjusts government might not have to intervene in future videos or in other videos we'll talk about how a government might want to intervene either direction but this is an argument that saying well look that in the short-run things might deviate from your full employment output but in the long run they're going to there's natural mechanisms that will allow output to get back to your natural potential your full employment output
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