LOS c: Differentiate between short-run and long-run macroeconomic equilibrium and explain how economic growth, inflation, and changes in aggregate demand and supply influence the macroeconomic equilibrium.

A decrease in aggregate demand can reduce output below its full-employment level. A decline in long-run aggregate supply would mean the full-employment output level itself has decreased. Wage rates are assumed to be fixed in the short run, but the long-run effect of decreases in wage rates would be to increase (shift) short-run aggregate supply, leading to an increase in output.

Because we assume money wages and resource prices to be constant in the short run, the economy can be in short-run equilibrium but long-run disequilibrium. Changes in money wages and resource prices are the factor that adjusts output back toward long-run equilibrium. If short-run equilibrium is above the full-employment level, aggregate demand has grown faster than long-run aggregate supply, so the price level has increased. With money wages constant in the short run, the rising price level has reduced workers’ real wages. As a result they will increase their wage demands. As producers increase the money wages they pay (note that our focus now changes from the short run to the long run), their costs increase, and they will supply less output at each price level. This represents a decrease in short-run aggregate supply (a shift left to a new SAS curve) and a move along the aggregate demand curve, increasing the price level further and reducing output to its full-employment level.

Starting from conditions of long-run equilibrium, unintended decreases in inventory levels suggest that aggregate demand has increased. Producers will respond in the short run by increasing output and prices, so economic growth and inflation will increase.