Question

Draw a dynamic aggregate demand and aggregate supply graph showing the economy moving from potential GDP in 2019 to potential GDP in \(2020,\) with no inflation. Your graph should contain the \(A D,\) SRAS, and LRAS curves for both 2019 and 2020 and should indicate the short-run macroeconomic equilibrium for each year and the directions in which the curves have shifted. Identify what must happen for the economy to experience growth during 2020 without inflation.

Short answer

In a dynamic aggregate demand and supply graph, the AD, SRAS, and LRAS curves all shift to the right to show growth from 2019 to 2020 with no inflation. The economy experiences growth without inflation when productive capacity increases, which can be due to factors such as resources' quantity or quality, better technology, or improved efficiency, causing both the AD and SRAS curves to shift rightward at the same price levels, leading to an increase in potential GDP.

Step-by-step solution

- Sketch the initial Graph for 2019

Start by drawing the 2019 curves. Draw a vertical axis to represent the general price level and a horizontal axis to represent output, or GDP. Draw a downward sloping AD curve and an upward sloping SRAS curve. The point where they intersect represents the macroeconomic equilibrium. The LRAS curve should be vertical and cross the equilibrium point - it represents the potential GDP for 2019.

- Illustrate the Shift to 2020

Draw the 2020 curves. The economy is growing without inflation, which implies that the AD and SRAS curves move to the right (increase) while staying at the same price level. The LRAS curve also shifts to the right, representing the increased potential GDP.

- Indicate the Equilibrium points

For both years, draw a line from the intersection point of the AD and SRAS curves straight down to the GDP axis - these points mark the short-run macroeconomic equilibrium for each year.

- Identify what must happen for the economy to experience growth during 2020

For the economy to experience growth during 2020 without inflation, productive capacity must increase. This might occur due to an increase in the quantity or quality of resources, improvements in technology, or more efficient production practices. This results in an outward shift of the LRAS curve.

Key concepts

Macroeconomic Equilibrium

In macroeconomics, equilibrium is a state where aggregate demand (AD) equals aggregate supply (SRAS) within the economy. This balance between demand and supply sets the point for GDP and the price level.
This intersection is crucial, as it indicates the output level at which the economy is operating efficiently without excess demand or supply.

• In 2019, the initial equilibrium is determined by where AD intersects with SRAS at potential GDP.
• In 2020, despite growth, equilibrium is achieved again where the renewed AD meets the updated SRAS, maintaining the same price level.

For a dynamic economy, understanding these points helps in identifying stable economic growth without overheating or underperforming.

Potential GDP

Potential GDP is the maximum output an economy can produce without triggering inflation when all resources are used efficiently. It serves as a benchmark for economic performance.
This is depicted by the Long-Run Aggregate Supply (LRAS) curve's position on the graph. A vertical LRAS implies that the economy can expand its capacity without leading to price increases.

• In 2019, potential GDP was at the intersection of LRAS with AD and SRAS.
• By 2020, potential GDP increased, marked by the rightward shift of the LRAS curve.

This shift represents improvements in productive capacities, such as technological advances or resource availability.

Growth Without Inflation

Achieving economic growth without inflation involves increasing output without a corresponding rise in price levels. This delicate balance can be visualized by observing rightward shifts in both AD and SRAS while the price level remains steady.
For this phenomenon to occur, several factors play a critical role:

• Advancements in technology can enhance productivity, allowing for increases in output per input unit.
• Increases in workforce skills or resources boost efficiency and capacity.
• Overall improvements in production methods contribute to enhanced output potential.

In our graph, this is reflected in 2020 by horizontal shifts of AD, SRAS, and LRAS, indicating growth alongside stable prices.

SRAS and LRAS Curves

The Short-Run Aggregate Supply (SRAS) and Long-Run Aggregate Supply (LRAS) curves illustrate different phases of economic output.
The SRAS curve is upward sloping, meaning that as prices increase, firms are willing to supply more. In contrast, the LRAS is vertical, reflecting the economy's capacity limits that are constant regardless of the price level.

• In 2019, SRAS and LRAS indicate the initial production capacities.
• In 2020, a rightward SRAS shift signifies increased production capabilities at existing price levels, while LRAS's shift demonstrates enhanced potential GDP.

These dynamics in SRAS and LRAS capture short-term adjustments and long-term growth potentials within an economy.